A recontribution strategy is something many people do once they reach an age where they are allowed to access their super.
It involves taking money out of your super balance and then putting it back in again (recontributing it). While it sounds like a waste of time (it certainly doesn’t help you grow your super balance), there can be important tax benefits. If you execute a recontribution strategy, those tax benefits won’t necessarily be for you – more likely they will be for people who inherit your super in the future when both you and your spouse (if you have one) have died. Often this is beneficiaries such as adult children.
Where do the tax benefits come from?
Everyone’s super balance can be split into two parts – a “taxable component” and a “tax free component”. Generally your tax free component comes from contributions you’ve made yourself where you haven’t claimed a tax deduction. Your taxable component is everything else. Most people have the vast majority of their super classified as a taxable component. That doesn’t mean they have to pay tax on it themselves. In most super funds (and certainly all SMSFs), any payment from your own super is generally tax free once you turn 60 even if it comes from a taxable component.
But some beneficiaries do pay tax – and then it becomes really important to work out how much of their payment is a taxable component (which will be taxed) and how much is a tax free component (which won’t be). A great example of someone who does pay tax is an adult financially independent child who inherits a parent’s super. In fact, they pay tax at 15% (+ Medicare unless it comes to them via their parent’s estate) on the taxable component. So someone who is about to inherit $1m in a super balance from their father would much prefer that it was a tax free component (no tax to pay) than a taxable component (in which case there would be a tax bill of 15% x $1m, $150,000).
And that’s where a recontribution strategy comes in.
It’s a way of turning “taxable component” money into a tax free component.
Let’s take the example of Steve, a 68 year old widower, who has $1m in super (all taxable component). If he died today, the tax paid by his adult children would be at least $150,000 (15% x $1m).
But what if he does a recontribution?
The first step is to withdraw some of his super – let’s say $330,000. This will obviously draw down on his taxable component (that’s all he has). But when he puts it back in again, he will be making a contribution from his own money for which he’s not claiming a tax deduction. That means the money going back in becomes a “tax free” component. If Steve was to die the same day and have the money paid out to his children (via his estate), the tax bill would be much lower at $100,500 (15% x ($1m - $330,000)) rather than $150,000.
(Note that there’s nothing magic about $330,000 when it comes to taking the money out in the first step. But that’s the most that Steve could put back in – so unless he actually wants to wind down his super balance, that will usually be the natural limit on how much he withdraws.)
And Steve could do more. There are two key ways to make a recontribution strategy even more effective.
For a start, Steve can do this more than once. As long as he’s still under 75 in three years’ time, there’s nothing to stop him withdrawing another $330,000 and recontributing it in (say) July 2025. But there’s a quirk. Unfortunately, if all Steve’s super is in one super account he can’t specifically choose that he only wants to withdraw out of his taxable component. Any payment he takes will be divided proportionately between the two.
Let’s say that Steve’s balance grew by 10% between making his first recontribution and his second. (And for the moment, assume that Steve hasn’t started a pension.) So when he’s ready to do his second recontribution, his super is worth $1.1m.
Of that amount, $330,000 has come from the personal contribution he made when he did his first recontribution. That bit (representing 30% of his super) is his tax free component. The rest ($770,000) is his taxable component. If he withdraws another $330,000 to kickstart his second recontribution, unfortunately 30% of it ($99,000) will be classified as a tax free component. That means the strategy won’t be quite as effective this time – instead of converting $330,000 of “taxable component” into a “tax free component”, he will only convert $231,000 ($330,000 less $99,000).
But there’s a second step Steve can take to solve this problem. Let’s go right back to the first recontribution. Before Steve puts the $330,000 back in, he could make sure that he starts a pension with what’s left in his original super account at the time ($670,000). The great thing about pensions is that they are kept separate from other super accounts (including other pensions). In three years’ time when he’s ready to do his next recontribution, he is allowed to specifically choose to take the withdrawal from his pension account. Conveniently, that means his withdrawal will be entirely taxable component.
Recontribution strategies are just one of many tools when it comes to making the most out of super. And they shouldn’t be considered in isolation. For example, Steve’s two recontributions would mean he couldn’t add to his super for 6 years. If he had other ways of building up his super he might be better to do that first before worrying too much about how much tax his children will pay.
There are also some traps to watch out for.
Remember that no-one can make contributions like these once they turn 75. In fact, up until 30 June 2022, it is actually difficult for anyone over 67.
Bear in mind also that how much someone can contribute depends on how much they already have in super. As long as Steve has less than $1.48m in super at (say) 30 June 2022, he can contribute $330,000 in 2022/23. But if his balance is higher, the maximum amount of his contribution might be lower. For example, if his super balance is $1.7m or more at 30 June 2022, he can’t make any of these personal contributions at all.
And finally, the objective here is to reduce the tax bill paid in the future by Steve’s children. But what if he ends up taking out all his super before he dies? In that case, the recontribution strategy won’t really have saved the family any tax – since there wouldn’t have been any to pay anyway.
All that said, recontribution strategies can be a powerful tool in managing tax for adult children, particularly when combined with pensions. It’s not surprising that they remain popular. If anything, they are likely to become more popular from 1 July 2022 when it becomes easier for those between 67 and 75 to make the requisite contributions.
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