A re-contribution strategy could help to reduce the tax burden on your superannuation death benefits
Many people are surprised to learn that upon their passing, if their superannuation goes to a non-tax dependant (such as an adult child) – tax of up to 15% (and possibly 2% Medicare levy) may be payable by the recipient.
However, by applying a re-contribution strategy, this scenario can be avoided. Two simple steps will help you to assess if this strategy is right for you
Step 1: Identify the tax-free and taxable components of your superannuation
When contributions are made to your super, they are either before or after-tax.
The after-tax contributions are considered a tax-free component and will always be tax-free.
The pre-tax contributions – such as employer superannuation guarantee and salary sacrifice contributions – are considered a taxable component. This taxable component will attract up to 15% tax (and possibly 2% Medicare levy) upon your passing.
If you have a significant taxable component, a re-contribution strategy may be an effective approach for you.
Step 2: Understand the conditions for implementing a re-contribution strategy
A re-contribution strategy involves:
- withdrawing a lump sum from your superannuation;
- paying any necessary tax on the withdrawal (if applicable); and
- re-contributing these funds back into superannuation as a non-concessional contribution.
The aim of this approach is to reduce the taxable component of your superannuation benefit by converting it to a tax-free component.
The main reason to implement a re-contribution strategy is to reduce the tax payable before a non-tax dependant (i.e., adult children) receives your superannuation death benefit.
Conditions for implementing a re-contribution strategy:
A re-contribution strategy can only be implemented if: you meet a superannuation condition of release; and you are eligible to make a contribution back into superannuation.
You should speak with your superannuation fund manager and/or your financial advisor to ascertain your eligibility to implement a re-contribution strategy.
Implementing a re-contribution strategy may also allow you to set up dual pension strategies:
If you decide that implementing a re-contribution strategy is right for you, it may also be possible for you to consider establishing two separate superannuation interests. (Note: For SMSF’s this is more complex and must be undertaken in a specific order of events. It is imperative to discuss this with your advisor ahead of making any decisions).
Having two separate superannuation interests may enable you to provide for both tax dependants and non-tax dependants. It may also allow you to reduce your taxable component at an accelerated rate, while preserving as much as possible from your tax-free component.
The pros and cons of a re-contribution strategy
As with all things financial, it is vital that you understand the advantages and disadvantages before you make decisions:
- If you are retiring before age 60: A re-contribution strategy may be beneficial for those aged between preservation age (from 58 years) and 60 years who are expecting to commence a superannuation income stream. This is because it may allow you to commence an Account Based Pension using tax-free component funds. Meaning income received before age 60 is potentially tax free.
- If you are looking to maximise your estate planning benefits: If there is a high probability that your superannuation benefits will be received by those not considered to be dependants under taxation law (i.e., adult children, charities, other family members), a re-contribution strategy can assist with reducing the lump sum tax payable upon death.
- There may be transaction costs such as brokerage and buy/sell spreads to withdraw then re-contribute the funds.
- By implementing a re-contribution strategy, your assessable and taxable income may increase for a particular financial year. This may impact on your individual tax position and also impact your Centrelink entitlements and family tax benefits.
- You may be liable to pay tax for the withdrawal from superannuation if you are aged below 60. This depends on the components of your superannuation.
- When re-contributing funds, if any amount exceeds specified limits, the non-concessional contribution may incur penalty tax.
- Investment markets may experience volatility throughout the implementation of withdrawing and re-contributing funds.