Recontribution strategy case study: How super tax components impact estate planning

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:

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.):

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.

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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.

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 or to contribute after 75 using the downsizer super contribution.