Recontributing to superannuation to reduce the taxable component of the balance while simultaneously increasing the tax free component is a strategy that has fallen out of popularity but may be worth reconsidering for some investors.
Legislative changes in July 2007 meant recontribution strategies lost some of their effectiveness. However, they may still be useful in certain situations outlined below.
1. Increasing the tax-free component of a transition to retirement (TTR) strategy being commenced prior to age 60
TTR strategies are very popular for people approaching retirement who have reached preservation age (currently 55) and want to boost their retirement lifestyle while maintaining a current target income level.
For those aged under 60, the benefit of the strategy before age 60 is generally limited to the tax-free investment earnings in pension phase, unless they already have a tax-free component in their superannuation fund.
This is because the 15 per cent tax rebate applicable on a pension is offset by the 15 per cent tax applied against employer and personal deductible superannuation contributions.
If someone has reached preservation age but is under 60 and has some unrestricted benefits in their super, they can elect to withdraw all or part of their unrestricted benefits and recontribute this amount to increase the tax-free component prior to commencing a TTR strategy.
The effect is to increase the tax effectiveness of any pension payment and, therefore, allows a more optimal strategy.
2. Reducing the taxable component of a future super death benefit that may be paid to a non-tax dependant
Since non-tax dependants pay tax on the taxable component of a super death benefit, there is a strong case for recontribution strategies to increase a member’s tax free component where there is a possibility that, in the event of death, a non-tax dependant would be the beneficiary.
This has become particularly important due to the change on July 1, 2007, that disallows the ability to commence a death benefit pension for a child unless they are:
- aged under 18; or
- aged under 25 and financially dependant; or
- suffering from an eligible disability.
This restricts the use of death benefit pensions for many non-tax dependant children to defer the payment of any lump sum death benefit tax.
In the absence of anti-detriment benefits, a recontribution strategy for this situation makes sense.
Unfortunately, maximising the tax-free component of a super balance may result in a decrease in the anti-detriment amount that may be payable to eligible beneficiaries (ie, a spouse or child).
This is of particular concern where the eligible beneficiary is a spouse or a tax-dependant child since they will not, in any case, pay any tax on the taxable component of a lump sum death benefit.
Even where the beneficiary is a non-tax dependant child, the result could be detrimental, for example, if the anti-detriment amount, where no recontribution strategy was employed, would be higher than the tax payable where the recontribution was made.
Unfortunately, unless any of the following apply, a tough choice is faced:
- a fund does not pay anti-detriment (although the appropriateness of such a fund should also be considered);
- there is certainty that a person’s death benefit will be paid to beneficiaries ineligible for anti-detriment; or
- the audit method calculation of anti-detriment will be higher than the formula method calculation.
It may be a case of making the options available to your client and letting them decide their preference.
3. Reducing the taxable component of a death benefit pension to an SIS dependant, although this is only of benefit if both the deceased member and beneficiary were less than age 60 at time of death
A recontribution strategy prior to age 60 may provide a better tax outcome for a death benefit pension beneficiary if the deceased was under aged 60 at the date of death or if the beneficiary has not reached age 60. Importantly, since anti-detriment benefits are not payable on super benefits used to commence a death benefit pension, a recontribution strategy will not provide a detrimental outcome.
4. Recontributing the amount for a younger spouse (under age pension age) to maximise Centrelink entitlements for a person over or approaching age pension age
Superannuation balances are exempt from means testing prior to a person reaching age pension age. Therefore, where one member of a couple is under age pension age, and the other is over age pension age, any potential age pension can be maximised by concentrating superannuation benefits in the name of the younger spouse until that younger spouse reaches age pension age. This may temporarily boost the older spouse’s social security benefits.
Other potential uses of a recontribution strategy
Recontribution strategies may also be worth considering for the following situations:
- quarantining the tax-free component in another fund so that two pensions can be commenced, with the higher taxable component pension providing the majority of pension payments. This may not be possible with a self-managed superannuation fund unless a pension is commenced with the remaining balance before the recontribution occurs.
- recontributing to a spouse who has already reached preservation age to allow them to maximise their TTR strategy; and
- recontributing to a non-working spouse for TTR purposes.
While the changes to superannuation rules have diluted the effectiveness of recontribution strategies, they are still a valid and viable strategy to increase a client’s wealth accumulation in some circumstances.
Tip: A further benefit arises from an estate planning perspective. From July 1, 2007, earnings in pension phase are effectively segregated between tax free and taxable components based on the proportions at commencement.
Case study
Having a higher tax free component at pension commencement will reduce the amount of taxable component of any future lump sum death benefit, which may be important where the beneficiary is a non-tax dependant.
Tom has just turned 55 and has $300,000 in his superannuation. His balance is comprised of a $30,000 tax-free component and a $270,000 taxable component. Due to rules that applied before July 1, 1999, $100,000 of his superannuation is unrestricted non-preserved and therefore available for withdrawal and recontribution.
Tom’s net of superannuation guarantee salary is $80,000 (and he has no other income) and he would like to use a TTR strategy. His required net income is approximately $60,000 per annum. Let’s compare the results of the following two TTR strategies (both commencing on July 1, 2009):
- TTR strategy without recontribution; and
- TTR strategy with recontribution: the $100,000 is withdrawn ($10,000 tax free and $90,000 taxable) and recontributed.
Assumptions: Employer continues to pay 9% contributions based on $80,000 salary in addition to salary sacrificed amounts, 10 per cent investment earning rate, $300,000 is transferred to pension phase.
Martin Breckon is technical marketing manager at Aviva Australia.
