Recontribution strategy

recontribution strategy
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What is the recontribution strategy
When this strategy applies – The definition of a dependent
Taxable and tax-free components of super
How much tax is payable
The strategies
Using a second super fund for the recontribution
Using your spouses super fund for the recontribution
Using this strategy in conjunction with other strategies
Downsides of the recontribution strategy
Getting more information

What is the recontribution strategy

The recontribution strategy involves withdrawing from your super and re-contributing it. The reason for doing this is that if your super is paid to a non-dependent when you die (e.g., a child over 18), part of that is taxable. A recontribution strategy can effectively ‘wash away’ the taxable nature so that your beneficiaries can get more of the money they inherit.

Before we begin, you might be thinking:

“Wait, I thought there is no tax within your super after it has been moved to an account-based pension, and there is no tax on withdrawing it after you’re over 60, so it is entirely tax-free.”

Yes, this is still true. There is no tax that you have to pay. This tax is specifically for beneficiaries who inherit your super when you die. And it is only for non-dependents, so it doesn’t apply to a spouse, minor children, or financial dependents who get it tax-free.

When this strategy applies – The definition of a dependent

There are two slightly different definitions of a dependent:

  • The definition under tax law dictates the taxable nature, and
  • The definition under superannuation law dictates whether your super can be paid to them when you die. If it can’t, your super can be paid to your estate (which means the collection of your assets after you die), and that can be paid to them under the direction of your will.
Beneficiary Superannuation
dependent		 Tax
dependent
Spouse — married/de facto Yes Yes Can be paid to them & no tax to pay
Spouse — former No Yes Cannot be paid to them
Interdependent Yes Yes Can be paid to them & no tax to pay
Child — under 18 Yes Yes Can be paid to them & no tax to pay
Child — over 18 Yes No Can be paid to them but is taxable
Financially dependent Yes Yes Can be paid to them & no tax to pay
Estate Yes No Can be paid to them but is taxable

Ignoring the case of a former spouse (who cannot receive your super directly), there are two specific types of beneficiaries where superannuation death benefit payouts are taxable (and therefore, this strategy is specific to these two cases):

  • a child over 18 who is not financially dependent on you;
  • your estate* (which can be distributed to anyone, according to your will).

* a tax dependent can still receive it tax-free, even if it is routed via (i.e., paid to) the estate first.

* and just for the sake of being interesting, a former spouse can still receive your super tax-free, but as they can not receive it directly from super, it would have to be routed via the estate first.

Taxable and tax-free components of super

Super balances are broken down into tax-free and taxable components.

The taxable component consists of your super that received a tax concession:

  • Concessional contributions (CCs)
  • Earnings within super accumulation accounts.

The tax-free component consists of your super that did not receive a tax concession:

  • Non-concessional contributions (NCCs)
  • Spouse contributions
  • Government co-contributions
  • Low-income super contributions
  • Contributions from the disposal of assets under small business CGT concessions
  • Downsizer contributions
  • Contributions relating to personal injury payments.
Essentially, the ATO is trying to get back some of the superannuation tax concessions you received before it is passed on to your beneficiaries after you die, but will waive it when passed to someone financially dependent on you.

Technically, there is another sub-type of taxable component, which includes the following, but to keep it simple, I will disregard it for now since it is not common and is likely to make it too confusing for most readers to understand:

  • Proceeds from a special type of super fund only available to public sector workers called ‘untaxed super funds’
  • Proceeds from a death benefit payment containing a life insurance component where the fund had deductions for premiums.

To find out how much of your super is tax-free and taxable, check your annual superannuation statement, and it will show:

Tax-free: $X
Taxable – taxed: $Y
Taxable – untaxed: $Z ← This will be zero for most people, so ignore this if that’s you.

How much tax is payable

When a person dies, for any super that is distributed to non-dependents under tax law (children over 18 or your estate), there is a 15% (maximum) tax applied to the taxable portion, but not the tax-free portion.

Let’s say that you die with $500,000 in super, and it is made up of a $100,000 tax-free component and a $400,000 taxable component. Any of that which your financially non-dependent adult children inherit (or which goes to your estate) will be required to pay up to 15%* tax. 15% of $400,000 is $60,000 in death tax. That’s $60,000 that your children won’t inherit.

The Medicare Levy also applies. So it would be even more – up to 17% if paid to a financially non-dependent child over 18 or 15% if paid to the estate.

* 15% is the maximum rate of tax. If an individual pays a lower rate of tax, the lower rate will apply.

The strategies

One way to avoid this is to leave your super to a financial dependent under tax law, such as a spouse and children under 18. However, this may not always be an option if you aren’t partnered or if your children are adults or if you are not sure that person will pass it on.

Another way is to withdraw it from your super and then leave it to your beneficiaries as part of your will. However, now those funds are back in a taxable environment for the remainder of your life. You could leave instructions in your Power of Attorney to withdraw it once it is evident you will not be around much longer, but there are risks with this. Firstly, you could have a quick death without enough time. Secondly, once it is outside super, it will be disbursed under your will, which can be contested.

Another way is to make use of the recontribution strategy – you withdraw money from your super fund and recontribute it to the fund as a non-concessional contribution, which is as a tax-free component. In the above example (which is not uncommon), your adult children could save up to $60,000 in tax.

The recontribution strategy is possible because there is an overlapping period where you can withdraw super and add to super. Once you reach preservation age, you can begin to withdraw your super, and you can contribute to super as a non-concessional contribution until the age of 75.

You can even begin the contribution strategy before you retire by using a Transition To Retirement (TTR) account. From preservation age, you can draw 10% per year from a TTR account, even if you are still working, and from 60 [1], there is no personal tax to pay on withdrawals. This can be recontributed back into super, not only reducing your tax as in the income swap strategy, but to begin ‘washing out’ your taxed component at the same time.

[1] Be aware that if you draw from your super before the age of 60, there may be tax to pay. So typically, the recontribution strategy is most beneficial from the age of 60.

Very important:

If you have started an account-based pension, do not draw from there for this strategy. Instead, move the amount from the pension back into an accumulation account first and withdraw it from there.

The reason for this is that you cannot make contributions – including recontributions – directly to a pension account. Contributions can only be made into an accumulation account and then moved into a pension account. Additionally, you have a limit on how much you can move your accumulation account to your pension account called the Transfer Balance Cap (TBC).

If you draw directly from your account-based pension and recontribute it back into your accumulation account, you will not have freed up how much of your TBC that you have used, and when you move it back into an account-based pension, you will use more of your TBC. If you instead move that amount back into an accumulation account before withdrawing, you are freeing up that amount of your remaining TBC for the recontribution so that once it is recontributed back into your accumulation account, the original amount of TBC that you have used up is restored.

How much tax can you save with the recontribution strategy?

When you draw money out of super, it is drawn out proportionally from each the tax-free and taxable components. And under the bring-forward rule, you can contribute up to a maximum of three years worth of non-concessional contributions – currently $360,000.

So the formula to calculating how much tax can potentially be saved upon your death when your super is distributed to a tax non-dependent, such as your adult children, is:

Min(balance, $360,000) x (taxable component / total balance) x 17% *

Let’s say you have the following:

Tax-free: $0 $0 $100,000
Taxable – taxed: $200,000 $600,000 $300,000
Taxable – untaxed: ** $0 $0 $0
Balance: $200,000 $600,000 $400,000
Potential savings: $200k x ($200k/$200k) x 17%
=$34,000		 $360k x ($600k/$600k) x 17%
=$61,200		 $360k x ($300k/$400k) x 17%
=$45,900

* Tax rate of 17% (= 15% + 2% Medicare levy) when passed directly to a non-tax dependent directly, or 15% if passed to the estate (which is then distributed under the will).
** Ignoring the untaxed component since it is not common and is likely to make it too confusing for most readers to understand.

Note that this is the maximum tax that can be saved within a three year period using the bring-forward rule. You can repeat this every three years as long as you are eligible to make non-concessional contributions (under age 75 and total super balance below the TBC).

Using a second super fund for the recontribution

There are thee benefits to using a second super fund for the recontribution (and for making any significant non-concessional contributions, such as using the bring-forward rule or downsizer contribution).

1. Washing away more of the taxable component

When you draw money out of super, it is drawn out proportionally between the tax-free and taxable components.

Let’s say you had $500,000 that was all taxable component that you wanted to convert to a tax-free component. If you drew out $360,000 to recontribute back into the same super fund, you would end up with 72% tax-free and 28% taxable.

If, after 3 years, you wanted to run this again, you cannot elect to draw out the last $140,000 of taxable. Instead, if you drew out $140,000, that will be composed of 72% tax-free and 28% taxable, so you have missed out on converting 72% of the remaining taxable component.

A way around this is to use a second super fund to recontribute back into to avoid contaminating the newly contributed funds. Then, after 3 years, when you run it again, you could draw the remaining entirely from the original super fund, where it is still mostly taxable to convert more.

You would still have a small amount of taxable component in the new super fund from earnings, but it would be a very small amount.

2. Splitting up death benefit nominations

In addition to the above, by using a second super fund for the recontribution, you can have death benefit nominations for non-tax-dependents with the pension account that is made up mostly of tax-free component, and death benefit nominations for tax-dependents with the pension account that is made up of mostly taxable component. This will result in less total tax payable upon your death since only non-tax-dependents pay tax from death benefits.

3. Drawing any additional money from the taxable account

If you need to take more than the minimum pension payment, having a second super fund allows you to draw the extra from the pension account with mostly taxable component to preserve more of the tax-free component.

Using your spouses super fund for the recontribution

Using your spouses super for the recontribution also has several benefits (and you can also use a second super account for your spouse if the previous section would be useful):

  • Allowing couples to have a larger combined balance that eventually moves into the zero-tax environment of an account-based pension (where the total balance of each person is $1.9 million, but combined can reach $3.8 million)
  • Allowing couples to have more super before the proposed additional 15% tax on the earnings of superannuation balances above $3 million kicks in
  • Retaining or recreating the ability to use unused concessional contributions for up to the past five years under the carry-forward rule for longer (where your total super balance on June 30 of the previous financial year must be below $500,000)
  • Retaining or recreating the ability to make non-concessional contributions and to use the bring forward arrangement for longer (where the total super balance must be below $1.9 million)
  • Retaining or recreating the ability to use the tax offset for spousal contributions for longer (where the receiving spouse’s total super balance must be below $1.9 million)
  • With an age gap, recontributing to the younger spouse can provide the following benefit:
    • Super (in an accumulation account) is not counted towards the age pension tests for those below age pension age. So, for couples with an age gap and where one member is approaching age pension age, recontributing to the younger spouse can potentially allow the older spouse to receive more age pension benefits.

Using this strategy in conjunction with other strategies

This strategy can be used together with non-concessional contributions, the bring-forward rule, and the income swap strategy by simply contributing or recontributing to a separate super fund for the reasons explained above. This will allow you later to draw from your fund with most of the taxable component and make after-tax contributions (or non-contributions) to the fund with mostly tax-free component. Note that having an additional fund will incur additional admin fees, but hopefully you are choosing a super fund with low fees.

Downsides of the recontribution strategy

There are a few things to be aware of with the recontribution strategy.

  1. There are still limits on how much you can contribute, so be aware of the consequences of that. If you were going to contribute the maximum to get your money into super, the amount you can contribute would be reduced by what you have contributed through the recontribution strategy. Similarly, if you already triggered the bring-forward rule, you will be limited by that with regard to the amount you can re-contribute within the active bring-forward period. Although, you can also recontribute it to anyone else’s super (such as your spouse) if their limits permit.
  2. If you have an account-based pension that was commenced before the 1st of January 2015 and you were also receiving social security payments at the time (e.g., the age pension) and you have continued since then, you may have less of your account-based pension counted towards the income test, resulting in potentially higher age pension benefits. The recontribution strategy may result in the loss of this.
  3. If you are under 60 when you withdraw the money from your super, you may be liable to pay tax for the withdrawal from super, depending on the components of your superannuation.
  4. Following on from the previous point, if you are under 60 when you make the withdrawal, your assessable and taxable income may increase in the financial year you make the withdrawal from your super, and this may impact your individual tax position and also family assistance benefits from Centrelink.
  5. Transaction costs, such as brokerage and buy/sell spreads, may apply when making transactions.
  6. Investments are volatile, so your investments may fall from the time you withdraw until it is recontributed
  7. There is more to learn if you are in an untaxed super fund, e.g., public sector funds, or if your super contains life insurance component where the fund had deductions for premiums.

Getting more information

As you can see from the downsides listed, this can potentially be complex, so you will need to do some more research into it. Start with your super fund, and you might like to consider seeking professional advice to make sure your strategies fit into a broad financial plan that suits your situation and to ensure the interaction of any one strategy meshes with the others.