Yes, taking money out of super only to put it back in using a recontribution strategy sounds pointless, but there’s method to the madness, especially where estate planning is concerned.
How does moving super help with estate planning? This involves understanding the impact of the tax components of super and their treatment when a death benefit is paid.
You will also need to be eligible to implement the recontribution strategy and stay within your personal contribution caps.
Tax components
For the purposes of estate planning and this case study, understanding the tax components within super is crucial.
- Tax-free component: Generally consists of contributions to super on which you have already paid tax, such as non-concessional (after-tax) contributions. No tax is payable upon the withdrawal of this component.
- Taxable components: Generally consist of concessional (before-tax) contributions to super such as employer Super Guarantee (SG) contributions, salary sacrifice or personal contributions you claim a tax deduction for. Investment earnings on your total balance are also added to the taxable component.
| Member | Tax-free component | Taxable component | Total balance |
|---|---|---|---|
| Paul | $200,000 (27%) | $550,000 (73%) | $750,000 |
| Fiona | $100,000 (20%) | $400,000 (80%) | $500,000 |
| Total | $300,000 (24%) | $950,000 (76%) | $1,250,000 |
Estate planning outcome without a recontribution strategy:
- Assume that Paul passes away at age 84 and his pension reverts to Fiona. Fiona then passes away at age 85 with the following super balances (using estimates from the Moneysmart Account-based Pension Calculator):
| Member | Tax-free component | Taxable component | Total balance |
|---|---|---|---|
| Paul’s reversionary pension account | $36,308 (27%) | $98,166 (73%) | $134,474 |
| Fiona | $17,817 (20%) | $71,266 (80%) | $89,083 |
| Total | $54,125 (24%) | $169,432 (76%) | $223,557 |
Estate planning impact:
- Fiona has made a binding death benefit nomination leaving her super death benefits to her adult son James.
- James would receive a total of $223,557 of death benefit.
- However, out of that total, $169,432 is taxable. Therefore, James would end up paying tax of $28,803 on the taxable component ($169,432 x 17% including Medicare) and the net death benefit would be $194,754 ($223,557 – $28,803). If the benefit was first paid into Fiona’s estate before being paid to James, the Medicare Levy would be avoided, and the taxable amount would not be added to James’ income for the purposes of calculating other entitlements and liabilities.
Estate planning outcome with a recontribution strategy:
Paul and Fiona use a three-stage strategy to reduce the taxable component of their super.
Stage 1: At age 65, Paul and Fiona withdraw $120,000 each and recontribute back into super as a non-concessional contribution. They make their contributions to new super accounts opened for this purpose, to keep the new tax-free component separate,
This changes their tax components as follows:
| Member | Tax-free component | Taxable component | Total balance |
|---|---|---|---|
| Paul’s original account | $168,000(27%) | $462,000 (73%) | $630,000 |
| Paul’s new account | $120,000 (100%) | $120,000 | |
| Fiona’s original account | $76,000 (20%) | $304,000 (80%) | $380,000 |
| Fiona’s new account | $120,000 (100%) | $120,000 | |
| Total | $484,000 (39%) | $766,000 (61%) | $1,250,000 |
As you can see above, the full $120,000 withdrawal doesn’t come out of the taxable component. This is how the withdrawal works:
- Under the proportioning rule, if 30% of your super account is a taxable component and 70% is a tax-free component, if you withdraw a lump sum amount, it must also have a 30% taxable component and a 70% tax-free component.
- As they are over age 60, they are not liable to pay tax on the taxable component. (They would be liable for tax on a withdrawal they were in an untaxed superannuation scheme.)
Stage 2: In July of the following financial year, Paul and Fiona use the bring-forward rule and withdraw $360,000 each and recontribute back into super as a non-concessional contribution. They withdraw from their original accounts that still contain mostly taxable component and make their contributions to their new accounts. By keeping the accounts separate, they maximise the amount of their withdrawals that come from the taxable component, reducing it (and the eventual tax to their son) as much as possible.
At this time, their super balances would be as follows (for simplicity, assume no change in overall super balance, ignore any market fluctuations, costs, etc.):
| Member | Tax-free component | Taxable component | Total balance |
|---|---|---|---|
| Paul’s original account | $72,000 (27%) | $198,000 (73%) | $270,000 |
| Paul’s new account | $480,000 (100%) | $480,000 | |
| Fiona’s original account | $4,000 (20%) | $16,000 (80%) | $20,000 |
| Fiona’s new account | $480,000 (100%) | $480,000 | |
| Total | $1,036,000 (83%) | $214,000 (17%) | $1,250,000 |
Importantly, if Paul and Fiona had not kept their new tax-free component in a separate account, the result would be very different. The requirement to draw proportionally from tax-free and taxable components would have required a smaller proportion of their second withdrawal to come from the taxable component, meaning more taxable component would remain.
Keeping tax-free accounts separate means that Paul and Fiona have generated an additional $106,000 in tax-free component versus what would have been possible if they used one account each.
Stage 3: Paul and Fiona start account-based pensions after stage 2 is complete. Because the balance of her original account is only $20,000, Fiona chooses to leave it in the accumulation phase rather than using it to start a very small pension. She starts a pension with her new tax-free account and draws the minimum.
Paul starts pensions with both his accounts, drawing the minimum.
Three years down the track, their balances are as below (using estimates from MoneySmart account-based pension calculator and superannuation calculator). Notice that the tax proportions of their pension accounts have remained the same. Once a pension has started, the proportions are fixed. The proportions in Fiona’s accumulation account have changed because the tax-free amount can only increase with further non-concessional contributions. Any growth in her balance goes into the taxable component.
| Member | Tax-free component | Taxable component | Total balance |
|---|---|---|---|
| Paul’s original account (pension) | $67,362 (27%) | $185,245 (73%) | $252,607 |
| Paul’s new account (pension) | $449,262 (100%) | $449,262 | |
| Fiona’s original account (accumulation) | $4,000 (19.5%) | $16,500 (79.5%) | $20,500 |
| Fiona’s new account (pension) | $449,262 (100%) | $449,262 |
As their original three-year bring-forward period has ended, Paul and Fiona, now aged 68, are eligible to make more non-concessional contributions to super.
Paul withdraws the entire balance of the pension he owns that contains taxable component and contributes it to a new accumulation account. The contribution of $252,607 is well below the maximum $360,000 permitted under the bring-forward rule. Indexation may also have increased the maximum permitted by this time.
Fiona withdraws and recontributes the $20,500 she has in her accumulation account.
As a result, all the couple’s super is now tax-free component. They commute (transfer/rollover) their existing pensions into their accumulation accounts to combine their balances into one account each, and each start new pensions made up of 100% tax-free component.
Because the taxable/tax-free proportion in a pension account does not change after it has started, Paul and Fiona’s pensions will remain 100% tax free until they have both passed away, when they can be inherited tax free by their son James. Remember, without a recontribution strategy, we estimated James would pay $28,803 in tax on the remaining super balance if his last parent passed away aged 85.
As you can see from the above example, planning ahead can mean more of your super death benefit ends up in the hands of your non-dependant beneficiary.
It is important to keep contribution caps in mind and plan to make all your required contributions before turning 75.
