Although it may sound a little odd, taking money out of super and putting it back in can actually be beneficial by reducing the amount of potential tax you or your dependents may pay in the future.
A recontribution strategy aims to increase the ‘tax-free’ component of your super account while reducing the ‘taxable’ amount. It is a little known fact that the source of the money in your super fund is tracked and updated each year. The balance of your superannuation is divided into two parts:
- The ‘tax-free’ portion is made up of the contributions where no tax deduction was claimed; usually when you made voluntary (non-concessional) contributions from your after tax savings.
- The ‘taxable’ portion is made up of any contributions where you or your employer claimed a tax deduction; usually the super paid by your employer, extra contributions you made through salary sacrifice and personal contributions where a tax deduction is claimed (known collectively as concessional contributions)
What are the advantages?
There are 2 potential benefits from increasing your tax-free account balance.
Firstly, to protect against future tax changes to superannuation withdrawals. Having a taxable balance doesn’t mean you’ll have to pay tax when you withdraw from your super. Under current tax rules, once you are over 60 withdrawals from super funds are tax free. Note that I write ‘under current tax rules’ as tax laws change often, especially around superannuation. Given the enormous amount of money in the superannuation system and the need for future governments to collect revenue, it is quite possible that a ‘retiree tax’ may creep back into existence (tax-free withdrawals for those over 60 only started in 2007 when the government had a healthy budget surplus).
Before 2007, when superannuation withdrawals were taxed, amounts taken from the tax-free component were exempt from tax. The reasoning here is that no tax deduction was claimed when the money went into the super system so no tax was payable on the way out. Money that was contributed by an employer or by salary sacrifice had received tax concessions, so amounts from the taxable component were taxed on withdrawal. The government is aware that they have only collected a 15% tax on the majority of money in the super system and they have the view that this is quite generous. It is well within the realms of possibility that a notional 5 or 10% ‘self-funded retiree tax’ will be re-introduced as a way of collecting tax. One way to protect against this is to maximise your tax-free balance.
Secondly, the other potential benefit is to reduce any tax that your dependents will pay on your death. The rules are complicated, but in summary an adult child or anyone else not financially dependent on the deceased will most likely have 15% taken away from the ‘taxable’ portion of your super before it is paid to them(plus Medicare, which takes it to around 17%), reducing the amount they receive in their pockets.
For example, you have a superannuation balance of $1m which is all taxable, upon passing your adult children beneficiaries would pay around $170,000 in tax/Medicare (17% of $1m), leaving them with $830,000.
This is where a recontribution strategy could assist in reducing your beneficiaries’ tax bill. If the same account balance was made of up $500,000 taxable and $500,000 tax-free, the tax would reduce to $85,000 leaving them with $915,000.
| Superannuation balance | Taxable component | Tax-free component | Estimated tax paid by beneficiaries (17%) | Balance received by beneficiaries |
| $1,000,000 | $1,000,000 | $0 | $170,000 | $830,000 |
| $1,000,000 | $500,000 | $500,000 | $85,000 | $915,000 |
It is unlikely there will be an immediate benefit to you as the potential tax savings will be seen later (and most likely by your beneficiaries, not you).
Considerations
Before you rush out and cash in all of your super, there are several things to bear in mind:
- Super contributions can only be made up to the age of 75
- To be eligible to make contributions to superannuation, your total super balance at the previous 30 June must be below the $1.9m threshold
- You have to meet a condition of release to be able to cash in your super
- There are ‘caps’ on how much you can contribute to super each year, which limits the amount one can re-contribute in any given year
- Withdrawals from super are taken in proportion to the existing taxable/tax-free percentage in your account, so you can’t elect to withdraw just the taxable amount.
This is an area that needs to be carefully planned and managed to ensure that withdrawal and contribution rules are complied with.
If you would like to discuss if a re-contribution is suitable for your situation, please contact me.
