September 11, 2017
Numerous superannuation strategies can be developed to enhance an individual’s position prior to retirement. Here we look at one of them, called the ‘re-contribution strategy’.
Re-contribution is an alternative strategy to rolling super into a pension. In this case, one takes a lump sum out of super first and then puts the money back into super as a non-concessional superannuation contribution.
The re-contribution strategy had been popular for many years amongst pre-retirees, as it increases the amount of a tax-free component in one’s super. This had traditionally determined the level of tax-free income received from a superannuation pension. The changed super rules now include tax-free pension drawings from age 60. To a certain extent, this change diminished the benefits of the re-contribution strategy from the personal tax perspective. However, this strategy still remains relevant for:
- tax purposes for those between 56 and 59 (inclusive), as well as for;
- estate planning purposes in the context of minimising the amount of tax paid upon death by non-dependants.
Improving the tax effectiveness of a superannuation pension from age 56 to 59
Prior to age 60, pension payments that flow out of super will comprise a mix of taxable component and tax-free component, in accordance with the ‘proportioning’ rule. Such pensions are taxed in the hands of the recipient prior to them turning 60, but include a deductible amount based on the tax-free component in their super. For individuals who will retire between their preservation age (currently 56) and 59, it is worth considering a re-contribution strategy that could help to deliver a more tax effective income stream – that is, just until age 60. Let’s look at an example.
Tracy is age 57 and has $500,000, from which to commence a superannuation account-based pension. Should Tracy do so, the resulting pension payments will comprise entirely of the taxable component – meaning the pension payments would be taxed at her marginal rate, but she would also receive a 15% tax offset. However, by carrying out a re-contribution strategy, Tracy could have withdrawn $200,000 and re-contributed this as a non-concessional contribution. The $200,000 withdrawal would not be subject to tax as it is within the 2017/18 low rate cap. Tracy is also able to make the full $200,000 re-contribution, as it is within the $300,000 ‘bring forward’ non-concessional contributions cap. The pension is then made up of $200,000 tax-free component and $300,000 taxable component. Under the proportioning rule, 40% of the income payments will be received tax-free. The 15% tax offset still applies to the balance of the taxable income received.
Estate planning – minimising tax paid by non-dependants
While personal tax benefits have a temporary effect – until the person turns 60, re-contribution can have a more significant effect on the tax paid on death by non-dependants.
The taxable component of a lump sum death payout may only be received tax-free by a death benefit dependant. The problem for death benefit non-dependants is that when they receive a lump sum death payout, they may be taxed at 17% on the taxable component. The 17% tax will apply to the taxable component, even if the deceased was more than 60 when they died (and could have withdrawn their superannuation, paying no tax at all). Therefore, for those with adult children (or other non-dependants), an effective estate planning strategy can be to perform a re-contribution strategy with the aim of limiting the taxable component.
In the earlier example with Tracy, were Tracy to die (assuming all her beneficiaries are death benefit non-dependants), the tax deducted on the lump sum payout would be $51,000 (i.e. 17% × $300,000) under the re-contribution strategy scenario. However, if Tracy did not do the re-contribution strategy, the tax deducted on payment of a lump sum death benefit to her death benefit non-dependants would be $85,000 (i.e. $17,000 × $500,000). That represents a potential tax saving of $34,000.
There are a number of points that need to be considered in relation to the re-contribution strategy:
- Preservation rules: When considering a re-contribution strategy, keep in mind that in order to be able to access superannuation, it is necessary to satisfy a ‘condition of release’, such as retirement.
- Eligibility to contribute and contribution caps: The person must still be eligible to contribute to super after receiving the lump sum. Also, annual limits apply to non-concessional contributions ($100,000 per year or up to $300,000 in one year for some people – under the ‘bring forward’ rule).
- Timing issues: There is a difference in the amount that can be accessed tax-free before and after age 60. Prior to age 60, the low rate cap ($200,000 in 2017/18) limits the amount that can be withdrawn without paying tax. However, beyond age 60, superannuation can be withdrawn tax-free.
- Individuals on low marginal tax rates: In some cases, the re-contribution strategy may not improve the tax position of individuals on lower marginal tax rates because of the 15% rebate on assessable pension income. From the personal taxation point of view, this strategy will be more beneficial for individuals on higher marginal tax rates.
- Effect on co-contribution and tax offsets: The taxable component of the superannuation withdrawn will be added to the person’s assessable income if the member is under 60. While that person may pay no tax on this component, its inclusion in the assessable income means that it could affect the person’s entitlement to the Government co-contribution and Low Income Offset.
- Prior superannuation withdrawals: The low rate cap ($200,000 in 2017/18) is the lifetime limit on the taxable component that can be withdrawn tax free by individuals aged 56 to 59. Therefore, any prior withdrawals need to be taken into consideration before implementing a re-contribution strategy.
- Capital gains tax and transaction costs/fees: In order to withdraw the money from super, some of the investments held in one’s super fund may need to be sold. This could result in a CGT event, with the subsequent taxation implications within the super fund. Some transaction costs, exit costs and entry fees may also apply and need to be considered.