Financial adviser Luke Smith tells how the recontribution strategy can help you create more appropriate tax and estate planning outcomes, in this extract from his book Smart Money Strategy.
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The recontribution strategy helps you plan more appropriate tax and estate planning outcomes, and possibly improve your Centrelink outcomes, by withdrawing money from your superannuation account (or account-based pension) and recontributing it back into your super (or account-based pension). Simply, it turns taxable components into tax- free components.
The strategy is only available to people who meet a condition of release to access their super and are still eligible to make super contributions – typically, people between the ages of 55 and 75 (depending on the year they were born).
How does it work?
Let’s take a look at two examples to see the recontribution strategy in action.
Estate planning and tax example
Mark is 67 and has turned his super income into an account-based pension. His $800,000 account-based pension balance has two tax components. Let’s keep the numbers simple as a general example:
■ Taxable component: $400,000
■ Tax-free component: $400,000.
If Mark dies, his adult children will pay 17 per cent (including Medicare levy) death benefits tax on the taxable component of his account balance that they receive. In this case that is $68,000 tax ($400,000 × 0.17).
Using the recontribution strategy, Mark could withdraw $330,000 from his account and make a personal non-concessional superannuation contribution back to a new account-based pension. The components of the withdrawal must come out in proportion to his existing account balance from both the tax-free and taxable components (you can’t just draw out the taxable amount only to get the outcome that you are after, unfortunately) – so he withdraws $165,000 from each component ($330,000/2). Mark can make this withdrawal and recontribution as he’s not previously used the bring-forward rule, so hasn’t passed any contribution caps.
Taking $330,000 out and directing it back to superannuation would increase the tax-free portion of his account and also limit the tax impact for his children. This means that Mark can start a new account-based pension along with his old one and have $565,000 as a tax-free component. This is made up of $235,000 in his old account ($400,000 – $165,000) and $330,000 in his new account. Mark may also wish to contribute the $330,000 to a new superannuation fund and lock in the tax-free status – it doesn’t necessarily have to go back into the same fund.
Strategy stacking tip
Remember to consider your overall position and the most appropriate control of your taxable components. You can add tax-free (non-concessional) money back into a superannuation account, but to make the most of the strategy and to lock in the tax-free status long term, use a second account to maximise the value of the recontribution strategy. Adding $330,000 to a new account and starting a pension ensures that any growth in the value of the new account is tax free over the long term. Always check your contribution limits and legislation at the time to ensure you can make the most of this strategy without falling foul of the rules.
The superannuation strategies
Centrelink example
In this example, Amir has the same $800,000 account-based pension with two tax components:
■ Taxable component: $400,000
■ Tax- free component: $400,000.
Amir is eligible for only some Centrelink Age Pension entitlements as he has assessable assets just below the assets threshold available. However, instead of recontributing his super back to himself, Amir can recontribute super to his wife, Zara, who isn’t eligible for Centrelink benefits because she’s below her access age. As a result, Amir is able to reduce his assets and access more Centrelink benefits, and Zara has had her super account boosted (provided she is under the pension age and has not commenced a pension, her assets would not be included in Amir’s Centrelink assessment).
When to do it?
The recontribution strategy is something to consider when you’re able to access your superannuation (you have met a condition of release) but you have not started a pension from your accumulated superannuation. Where you are under the age of 60 and have met a condition of release (met the age that you can access your superannuation), you could start a pension from your superannuation; however, increasing the tax free percentage of your total fund would maximise the tax-free status of any pension income that you draw prior to 60 as you would have added to the tax-free components of your superannuation by making a recontribution.
Controlling the estate planning impact of your superannuation and pension accounts is important to limit the tax impact on the transfer of assets. You should also consider the trading and tax implications of selling assets within your superannuation fund as capital gains tax may apply. If you have to sell assets to take money out of superannuation to undertake the recontribution strategy, you need to consider the trading costs as well as any associated capital gains on the assets being sold before pulling the trigger.
From a strategy perspective, it may be worth Amir starting a pension, selling his high-tax assets (as a pension account is free from capital gains tax) and withdrawing the proceeds of the sale of the asset to add back to Zara’s super fund. This could help avoid unnecessary capital gains tax as part of his broader strategy.
Do consider a recontribution strategy
■ as part of looking at an Appropriate Tax in Super Strategy and an Estate Planning Strategy
■ when your Centrelink benefits will help you live a more comfortable retirement
■ if you’re comfortable with making a contribution to your spouse’s super, which means it’s locked away until they reach retirement age and it legally becomes their money
■ if you intend to start a pension from your superannuation when you are under the age of 60 and wish to limit the tax impact on your income stream.
Don’t fall into these traps
■ forgetting that saving to your super means you generally cannot access the money until retirement age. This especially applies if you’re making a recontribution to your spouse.
■ forgetting that the withdrawal must come out in the same proportion of your existing superannuation fund so you may have to draw out more than you need on a percentage basis to reduce your taxable component
■ forgetting to consider the tax implications when selling assets to fund the recontribution
■ losing track of your non-concessional contributions. If you have already used your non-concessional limit, you may be unable to get all the funds back into superannuation. Check what has been happening in relation to non-concessional contributions in your super over the past three years.
Knowing the rules helps you play the game better
This strategy might seem a bit silly – you’re taking something out just to put it back in. At no point in this book do I suggest that the rules aren’t without their problems – or that they always make sense.
The art of strategy, regardless of the situation, is about knowing the rules of the game and when to use them. It could be going for that field goal or shooting a hoop just before the siren signals full time. It could also be having set plays during key points of the match. The same goes for your financial strategies, yet most people let opportunities pass them by because they never spent any time learning the rules of the game or seeking advice from someone who did.
The basis of most people’s ‘why’ is to maximise their overall position both now and in the future (through your children and your estate planning). Seeking financial advice can make a significant contribution to your financial life over your lifetime; it can also help the next generation on their journey, too.
Have you used the recontribution strategy? Why not share your thoughts in the comments section below?
Also read: Explained: Spouse contribution strategy
Luke Smith is also a licensed financial planner and the director of Envision Financial, a financial planning advice business he founded in 2016 in Canberra. He says we have become a society of haves and have-nots and believes the key to closing the gap is financial planning education.
