The power of re-contributing
The power of re-contributing
Re-contribution strategies can reduce the tax liability of an SMSF and its beneficiaries as well as allow members to qualify for Centrelink benefits. Karen Dezdjek illustrates how.
A re-contribution strategy for SMSFs is easy to implement. It has the potential to deliver significant tax savings to both the member and their beneficiaries when a member dies, not to mention potential access to Centrelink benefits they may have otherwise forgone.
So what exactly is it?
As its name suggests, a re-contribution strategy is where money is withdrawn out of the SMSF from a member’s entitlement and then deposited back, allocated to the same member or even the member’s spouse.
A member’s balance typically consists of two components – a taxable and tax-free component. A taxable component is derived from employer or member contributions where they have claimed a tax deduction. The tax-free component results from a contribution into the fund where no one is claiming the amount as a tax deduction. The idea behind the strategy is to convert a member’s balance that is predominantly taxable into a balance that is predominantly, or entirely, tax-free.
Sounds easy. So what’s the catch? In order to use this strategy a member will need to meet a condition of release to be able to access their benefits and then be in a position to re-contribute the money back into the fund either for themselves or their spouse.
What are the benefits?
Like most strategies the main aim is to save on tax. This strategy has potential benefits for anyone who has a taxable component and is able to access their entitlement.
Members up to age 60
Those who are under the age of 60, have permanently retired, have a high taxable component in their member balance and wish to begin a pension to have the ability to save some tax can benefit from the strategy.
As we know, drawing a pension from the fund up until age 60 will mean there will be tax payable at the member’s marginal rate less the 15 per cent tax offset. However, if a condition of release, such as retirement, has been satisfied, a member can use their tax-free lifetime cap by withdrawing up to $195,000 (2015/16 rates) and then re-contribute this amount back into the fund as a non-concessional contribution. The non-concessional cap is currently set at $180,000 a year with the ability to bring forward an additional two years of non – concessional contributions. It is important a member checks they haven’t previously triggered the bring-forward provision before using this strategy, otherwise an excess contributions assessment will be issued.
Members aged between 60 and 65
As previously discussed, when a member turns 60 the pension is no longer included in their personal tax return. Many would argue there is no longer a need to use a recontribution strategy and, from a personal tax perspective, they are correct (assuming the government continues not to tax pensions). However, there are still potential benefits that will arise from an estate planning perspective and, potentially, access to Centrelink benefits.
Many people are under the impression death taxes don’t exist in Australia. Unfortunately, there is a form of death taxes that are levied when non-dependants receive a death benefit that contains a taxable component. Members over 60 who anticipate there will be a benefit remaining after they die can potentially save their non-dependent beneficiaries (adult children) a significant amount of tax, ensuring the maximum entitlement possible is received.
Members aged 65 and over
Let’s consider Jim who has a super balance of $850,000. He is married to Sally who is 61. Jim will turn 65 in six months and would like to be eligible to receive Centrelink entitlements. In his current situation he will not be entitled to any Centrelink benefits as he has too much in his own name. Jim decides to withdraw $540,000 from his superannuation entitlement as a pension and re-contribute this back into the fund in Sally’s name. Doing this will allow Jim’s superannuation entitlement to drop below the cap and he will be eligible to receive a part pension. The good news is that by contributing to Sally’s balance, and if she remains in accumulation mode, her entitlement is not counted by Centrelink. Jim and Sally will enjoy some form of Centrelink benefits for at least the next few years until Sally turns 65.
Are there any disadvantages of using a re-contribution strategy?
While there are a number of advantages, like all strategies there are always a few points to consider. Fora re-contribution strategy to work, a member must physically withdraw the cash from the fund. If the fund is heavily invested in assets such as shares, there may be a need to sell down assets and incur costs such as brokerage.
Some of the assets may be held in investments that take time to liquidate and therefore there is the opportunity cost of not being fully invested.
If a member is currently receiving an entitlement from Centrelink, the amount withdrawn may affect the member’s ability to continue to receive the entitlement in the short term. This could mean loss of the pension, as well as the valuable health benefits card that could prove quite disastrous financially.
Finally, if a re-contribution strategy is used, the fund will lose the ability to use the anti-detriment provisions. This should be considered if the entitlement is to go to a dependant, as they will lose the ability to claim an anti-detriment payment.
Within this article, there are two case studies (not included in this posting) to provide a clearer understanding. If you would like further information, please contact our office on 02 9954 3843.
Please note that this article is not professional advice however only general information only. Please do not act on this article without further advice.
‘The power of re-contributing’ Self-Managed Super Magazine written by Karen Dezdjek (Quarter 1, 2016, Issue 013): 48-50. Print