Case study: Super recontribution strategy to reduce death benefits tax

• Fiona has made a binding death benefit nomination leaving her super death benefits to her adult son James.
• James would receive a total death benefit of $616,200.
• However, out of that total, $467,081 is taxable. James would pay tax of $79,404 on the taxable component ($467,081 x 17% including Medicare levy), and the net death benefit would be $536,796 ($616,200 – $79,404).
• If the benefit was first paid into Fiona’s estate before being distributed to James, no Medicare levy would apply, 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 $130,000 each from their super and use it to make non-concessional contributions. They make their contributions to new super accounts opened for this purpose, to keep the new tax-free component separate.

They tell their super fund that they are deliberately holding two accumulation accounts, so the administrator doesn’t automatically consolidate them into one. This is an important step in the process, because super funds are required to automatically consolidate your accounts if they believe it is in your best interests.

When using multiple accounts, care must be taken to prevent future consolidation of the interest/account holding a large tax-free component with another interest/account reflecting a lower tax-free proportion. Professional advice is recommended.

The withdrawals and contributions change their tax components as follows:

As you can see above, the full $130,000 withdrawal doesn’t come out of the taxable component. This is how it works:

• Every withdrawal from a super account is drawn proportionally from the tax components that exist in the account on the day of the withdrawal. For example, if your account is 70% taxable and 30% tax free, your withdrawals are also 70% taxable and 30% tax free.
• Because Paul and Fiona are over age 60, they do not need to pay tax on the taxable component of their withdrawals. (They would be liable for tax on the withdrawal if the taxable component included an untaxed element from an untaxed super scheme.)

Stage 2

In July of the following financial year, Paul and Fiona make more withdrawals from their original super accounts. Paul withdraws $390,000 and Fiona withdraws her entire remaining balance of $370,000. The couple uses the withdrawn amounts to make non-concessional contributions to their new accounts. The bring-forward rule means that they will not exceed their non-concessional contribution caps.

By taking the withdrawals from their original accounts that still contain mostly taxable component and adding their contributions to their new accounts, Paul and Fiona keep their new tax-free component separate from the taxable components. This way, 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, we have assumed no change in overall super balance, ignoring any market fluctuations, costs and similar factors):

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 means a smaller proportion of their second withdrawal would come from the taxable component, and more of the taxable component would remain.

Keeping tax-free accounts separate means that Paul and Fiona have generated an additional $114,468 in tax-free component in this step versus what would have been possible if they used one account each.

Stage 3

After stage 2 is complete, Paul starts pensions with both his accounts and Fiona has one account that she also uses to start a pension. They draw the minimum from the pensions that hold a 100% tax-free component. All the additional income they need is taken from Paul’s pension that contains some taxable components. This way, they continue to reduce the taxable component as much as possible.

Three years down the track, their estimated balances are as below. Notice that the tax proportions of their pension accounts have remained the same. Once a pension has started, the proportions are fixed.

Because 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 that contains a taxable component and contributes it to a new accumulation account. The contribution of $184,018 is well below the maximum $390,000 permitted under the bring-forward rule. Indexation may also have increased the maximum permitted contribution by this time.

After this step, all of the taxable component has been eliminated. Paul commutes (transfers/rolls over) his existing pension into his accumulation account to combine his balance into one account, and starts a new pension made up of a 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 $79,404 in tax on the remaining super balance if his last parent passed away aged 85.

As you can see from the above example, forward planning can put more of your super death benefit in the hands of your non-dependent 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.