Q&A: How can we reduce the super death tax for our beneficiaries?

A: What we are looking at here is a really common strategy. You read about it almost every day in financial press. I know we’ve covered it through numerous webinars and articles. It’s around reducing taxes, what we call death taxes on superannuation, when a member passes away. Quick introduction or quick background to this. Tax is payable on benefits in super or on superannuation death benefits if they’re paid to non-dependent people on our death. The thing is that non-dependents include our adult children. Spouses are dependent, so no matter really how old we are, most super death benefits that we pay to our spouses on our passing are tax-free. But benefits to then pass to an adult child aren’t necessarily tax-free.

What happens is we look at the components of the death benefit, and it will be broken up into the tax-free component, and it will be broken up into the taxable component. We’ll cover what happens there shortly, but your tax-free component usually comprises of your non-concessional contributions which have been made. The taxable component usually includes all your personal contributions for which you claim a tax deduction, or your employer contributions, and all the earnings over the years. They form the taxable component. Where that taxable component is paid out to non-dependents, so to adult kids, they can pay tax, usually around 15% plus Medicare on the taxable component.

If there’s any untaxed element, usually relates to things like insurance policies or other things, the tax can be as high as 30%. So, people often don’t like that. They don’t like the fact that, “Hey, if I pull the money out a day before I die and I’m over 60, it’s tax-free, but if I leave it in super and it goes to my kids, then they’re going to pay tax on some of that money”.

What we look at, or what’s often discussed, is the use of the Recontribution strategy. If the recontribution strategy is carried out effectively, it can reduce or even eliminate that death tax payable by our kids. The way it works is we pull money out from super. When we pull money out from super, we need to do it proportionately. Let’s just say that I’ve got a million dollars in my super, 50% tax-free and 50% tax-free. If I pull $100,000 out, it’s going to come $50,000 from tax-free or $50,000 tax-free. I pull it out, it’s tax-free to me. Then if I recontribute that amount back in as a non-concessional contribution, it forms part of the tax-free component which goes to my kids tax-free. The whole recontribution strategy involves us withdrawing an amount from Superfund. The payments come from our fund proportionally from both the taxable and tax-free. If you’re eligible to access those amounts in your 60 plus, those amounts to you are tax-free. Once you’ve got those amounts, you can then recontribute these if you’re allowed under the caps and the limits. You can recontribute those amounts as non-concessional contributions, and they form part of the tax-free component.

As I said, it’s a tax-free component which gets paid out to our kids, to non-dependents, including adult kids, tax-free on death. It’s a simple recontribution. Money comes out, money goes back in. We’re washing the money from taxable to being tax-free. Just some considerations around doing this. You need to be eligible to access your super to do this. If you’ve retired after age 60, which is ceasing an arrangement under which you’re gainfully employed, that means you’ve met a condition of release and would allow you to access your super. Because you’re over age 60, amounts that come out of tax-free.

Do follow the required process for your fund, it could be required notices to let them know that you’ve retired, that you’re no longer working, and then request for money to be paid out to you, either by way of a lump sum or a pension. It’s up to you and make sure you follow the fund rules. Then when you put the money back in, make sure you follow the required process that your fund needs. Again, they’ll have specific forms around contributions and the type of the contribution. Once the contribution is being made, it has to go, of course, into the accumulation phase. You can’t contribute to any existing pension. It’s got to go to the accumulation phase. Then think about the timing of pensions. The reason I just talk about pensions is you might want to think about doing these things before your pensions start. I’ll come back to that in a second. What I’m getting at here is if you do the recontribution strategy, if you’re thinking of doing it, quite often it’s worth doing this before we start pensions.

Otherwise, you might need to run multiple pensions. Once you’ve pulled money out, when you put that contribution back in, it must go to the accumulation. You can’t contribute to an existing pension. If the pension starts, if you start a pension before making that recontribution, you’ll need to start a new pension, run multiple pensions. If the pension starts after the contribution is made, so we withdraw money, make the recontribution, and then start a larger pension, you might be able to do that with just the one single pension.

Again, some more details on the website around death benefits and taxes. Have a look at that. It does go through the differences between dependents and non-dependents, or if it’s even paid to your estate. So have a look at that article. Further information on the recontribution strategy was only updated a couple of weeks ago, I think, at the latest. It takes you through what the recontribution strategy is and how it works. So have a look again at Kate’s article on how recontribution strategy works.

Q2: My question relates to how my wife, and I can utilise the tax minimisation benefits of the recontribution strategy in relation to our daughter who will inherit our super after we both die. At this time my wife and I are each other’s reversionary beneficiaries. We both recently turned 60 and are now fully retired. We have also recently converted all of our super from accumulation funds to pension accounts. As currently a high percentage of our super is taxable component, are we able to simply withdraw $360k each from our pension accounts (we don’t have any current amounts already brought forward) and put these amounts back into the same existing pension accounts as non-concessional contributions? Our concern is that we may have needed to do this while still in the accumulation phase?

Thank you for your question. This is exactly what we were just looking at in that prior question. Everything that we just went through when it comes to the recontribution strategy, all that is relevant for this question. Really, to bypass and not need to repeat myself around all that, the amount that you take from an existing pension or amounts that you take from super can’t be recontributed to a pension. All contributions that get made to super; all contributions need to be allocated to your accumulation account. Once that pension commences, you are not allowed to add any further capital to that pension. It can grow by way of fund earnings and returns, but we can’t add new money or capital to that pension. All contributions need to go to your accumulation account. Now, once those amounts have been contributed to your accumulation account, you’ve then got a couple of options. You can commence a new second or third or fourth or fifth pension. You just run multiple pensions. Or if you wanted to, totally up to you, you could stop what we call ‘commute’ or ‘roll back’ any existing pension back to accumulation, which gets added to those contributions you’ve made, and then start a new pension with all the money, so you have a new high-valued pension.

Again, what I’d be looking at here is the tax components that make up those contributions and the tax components which make up those pensions. It’s not uncommon for people to run multiple different pensions, each with their own different underlying tax components. The key here is that you can’t contribute to your pension. You need to contribute to your accumulation account. It doesn’t mean that you have to do it while in accumulation phase. It just means that you now need to run multiple pensions. You can still do the recontribution, but it won’t be contributed back to the existing pension. It will go to the accumulation phase.

There is a recontribution strategy case study on our website. Have a look at it. It might add some more value to you as well.