When would you choose not to use a recontribution strategy?
Important reasons to consider avoiding implementing this strategy include:
- A member who has not obtained a condition of release and is unable to access their super is ineligible to use the recontribution strategy.
- A member who may be able to access their super account may not be eligible to recontribute super.
- Account-based pension (ABP) established prior to 1st January 2015 are grandfathered pensions which can impact on the income test in relation to some Centrelink payments such as the aged pension and the level of aged care fees. A grandfathered pension can also impact the holders of Commonwealth Seniors Health Card (CSHC) who receive benefits including cheaper medicine under the pharmaceutical benefits scheme and depending on the State or local government may also include concessions such as cheaper council rates, public transport, health care and electricity.
These concessions need to be considered when using the recontribution strategy.
Please discuss your situation with our SMSF Specialist or a Licensed Financial Adviser to determine the impact of using the recontribution strategy on your Centrelink or CSHC benefits.
How do tax components work?
The underlying components of your super benefit include two major components being taxed and tax-free components. The recontribution strategy may help in building up your, or your spouse’s, tax-free components.
Generally, taxable components result from employer super contribution, super guarantee contributions and taxable member super contributions as well as income earnings from all investments. Usually, the tax-free component arises from member non-concessional contributions. downsizer contributions and small business CGT contributions.
The tax components are calculated just before it is paid for each lump sum payment and for an income stream the calculation time is when the pension is started and is set for the life of the pension. The reversionary beneficiary of a death benefit pension continues the same underlying tax components as the deceased member.
When withdrawing a lump sum or a pension payment tax is based on a number of factors. The underlying tax-free amount remains tax free to the recipient, regardless of how old the recipient is. There are exceptions in relation to defined benefit pensions and illegal access which are beyond the scope of this article.
There are some exceptions in relation to special conditions of release (refer to our resources page for further information) which are subject to different tax treatment and include:
- terminal medical condition – the tax payment is tax free regardless of age and tax components
- permanent incapacity – taxed like any superannuation lump sum but the calculation of the tax-free component takes into account the period of time the member could have been expected to be employed but due to their incapacity is unable to do so
- temporary incapacity – is taxed at the member’s marginal tax rate regardless of underlying tax components
- release authorities – are not taxable
- illegal early access – the full amount of the payment is included in the individual’s assessable income regardless of the tax components
There is a third component being an untaxed component which is relatively rare in a SMSF. We have not addressed this component. Please refer to your SMSF Specialist for details if you have an untaxed component.
What is the proportioning rule?
When a member’s super is withdrawn it must be paid in the same proportion as the underlying tax-free and the taxable components from the member’s super account. You cannot select the component to be withdrawn. A pension keeps the same proportion of tax components when it is calculated at the start of the pension and does not change even when paid out as a lump sum benefit. However, a member’s accumulation account is constantly changing depending on earnings, contributions made and withdrawals.
Example – Gary withdraws $100,000 from his SMSF. He has an accumulation account with a balance of $500,000. Just prior to the withdrawal his tax components were 20% tax-free and 80% taxable components.
Gary has met a condition of release and he is over 60.
$20,000 will be tax free and $80,000 of his super benefit will be subject to tax. As Gary is over 60 no tax is payable.
What is preservation age?
A member reaches their preservation age at 60. Once a member attains their preservation age and ends their employment (typically by leaving a job where they worked for 10 hours or more), or if they plan not to work again in the future, they can qualify as retired and withdraw their superannuation balance.
Advantages for Non-Tax Dependants
A lump sum death benefit paid to a tax dependant which includes a spouse, a child under 18 or a beneficiary who had an interdependency or a financially dependent relationship with the deceased prior to their death is tax free. However, a non-tax dependant which usually includes an adult child over 18 and not financially dependent on the deceased is subject to tax.
Adopting a recontribution strategy can reduce or completely eliminate the tax burden on your adult child.
Example – In accordance with Don’s binding death benefit nomination he wants his death benefits paid as a lump sum to his adult son Andrew. Currently Don’s super balance is in accumulation and is $500,000 consisting of $300,000 (60%) taxable component and $200,000 (40%) tax-free.
Don has met a condition of release, and he is over 60. Don is eligible to access the bring forward rule and can contribute up to $360,000 as a non-concessional contribution.
If Don died Andrew (he is on the top marginal tax rate) would pay tax at 17% (includes Medicare levy). Tax would be 17% x $300,000 = $51,000.
However, if Don withdrew $360,000 (maximum amount NCC he can bring forward in 2024/25), he would not pay tax on the lump sum as he is over 60. He then recontributes $360,000 as a non-concessional contribution using the bring forward rule. He then starts an account-based pension to lock in the tax components.
| Carry Forward Super Balance
$ |
(Withdrawal)/Contribution
$ |
Tax Free
$ |
Taxable
$ |
Super Balance
$ |
| 500,000 |
|
200,000 |
300,000 |
500,000 |
| 500,000 |
-(360,000) |
-(144,000) |
-(216,000) |
140,000 |
| 140,000 |
360,000 |
360,000 |
0 |
500,000 |
| 500,000 |
|
416,000 |
84,000 |
500,000 |
Don has shifted the tax-free percentage from 40% to 83.2%. The tax payable by Andrew on the death benefit would change from $51,000 to $14,280.
Eligibility Criteria for Withdrawing from your Super Account
Before checking the member’s eligibility to withdraw super you need to ascertain if the fund has sufficient cash to make the withdrawal or does the fund need to sell assets, possibly triggering capital gains tax. Alternatively, it may be possible to pay as an in-specie withdrawal provided the asset is sold at market value and the title is transferred to the member. Cash or an asset must be paid from the fund to the member for it to count as a legitimate withdrawal. A withdrawal can be made from your pension account as a pension payment or a partial commutation from an account-based pension (unable to do this from a transition to retirement pension) or from the member’s accumulation account as a lump sum payment.
Eligible criteria to withdraw super (refer to our resources page “Paying Benefits“) include:
- turning 65
- turning 60 years of age, but not having turned 65, and retired
- the death of a member
- reaching preservation age and starting a transition to retirement pension
- satisfying the criteria for early access to super
- unrestricted non preserved benefits
Tip – When a benefit is paid it is most beneficial when it is tax free to the recipient and the recontribution is a non-concessional contribution
Eligibility Criteria for Super Recontribution
A recontribution can be made to your accumulation account or it may be more strategic to contribute to your spouse’s super account.
The following contribution rules need to be considered when recontributing to super:
- members under 75 can make contributions such as employer concessional and member concessional contributions (must meet a work test requirement or work test exemption if the member is 67 to 74 years old to claim a personal contribution deduction} or, member non-concessional contributions
- downsizer contributions can be made provided the member is 55 years or older
- spouse contributions
- concessional cap which is $30,000 from 1 July 2024
- carry forward unused contribution cap amount – your total super balance must be less than $500,000 at 30 June of the previous financial year and can only carry forward up to 5 previous years
- non-concessional contribution cap which is $120,000 from 1 July 2024
- bring forward non-concessional contributions – if your total super balance (TSB) at 30 June 2024 is:
- $1.9million dollars you are ineligible to use the bring forward rule
- less than $1.66mil you can bring forward $360,000 of NCC over 3 years
- less than $1.78million to $1.66million you can bring forward $240,000 of NCC over 2 years
- less than $1.9million to $1.78million you can bring forward $120,000 of NCC over 1 year
- TSB which is $1.9million at 30 June 2024 includes all of your accumulation and pension accounts (retirement phase values measured when pension starts) across all super funds and possibly outstanding limited recourse borrowing arrangements, rollovers and structured settlement contributions
- TSB affects eligibility to carry forward concessional contributions, bring forward non-concessional contributions, work test exemption, government co-contribution and spouse tax offset
It may be possible to contribute an asset to the fund as an in-specie contribution. It is crucial to ensure it is one the fund is able to acquire, and it is valued at market value.
What is the Tax Rate on Your Withdrawal and Recontribution?
It depends on a number of factors. Generally, a super lump sum payment made to a member over 60 is tax free and also for a pension payment. There is no tax deduction for contributing a NCC to your fund as a NCC is made from after- tax income. A tax deduction may be available if recontributing a member concessional contribution which attracts a tax deduction at the member’s marginal tax rate.
Consideration of Part IVA Tax Avoidance
The ATO accept that a recontribution strategy will not be tax avoidance where simple, common strategies are used. A recontribution designed to produce a tax-effective income stream is acceptable as the purpose is to create an income stream that maximises the available tax concession pool, but the strategy is not solely to obtain a tax benefit. A common reason for entering into a recontribution strategy is for estate planning purposes to provide for adult beneficiaries on the death of a member.
A private binding ruling (PBR) 79101661077376 indicated that the ATO would allow that a person can be eligible to claim a personal superannuation contribution as a tax deduction following a lump sum withdrawal from their super fund. The member had a history of making personal superannuation contributions to their fund and claiming a tax deduction. A PBR cannot be relied on, but it is indicative of the ATO’s views. It would be wise to request a private ruling if wanting to do something similar.
It is important that the dominant reason for entering into a recontribution strategy is not solely to obtain a tax benefit.
The Key Takeaways
- Access your super and withdraw part of your super and recontribute money into your super account as a non-concessional contribution
- Consider estate planning strategy to reduce the taxable components for paying a death benefit to an adult beneficiary
- Consider a recontribution strategy is to reduce one member’s TSB and increase the tax-free component of the spouse’s super balance
- Consider tax-free and taxable components
- An adult child is considered a non-tax dependant
- Consider eligibility rules to withdraw super and recontribute super
- Consider Part IVA tax avoidance
Do you need help with understanding Super Recontribution Strategy?
Give us a call on 1300 392 544 or get in touch online
This is a common strategy which is very useful for tax planning and estate planning. It is a way of recycling underlying tax components into tax free components. The ATO may view any strategy which is solely implemented to reduce your tax liability without any other benefits being received as tax avoidance.