It is a reasonably common strategy recommended by financial advisers to their clients under certain circumstances.
So, what is a recontribution strategy?
To understand a recontribution strategy, it is important to first understand superannuation tax components.
The reason tax components (or tax elements) are important is because they determine the validity of a recontribution strategy.
Ultimately, you want your super balance to have a high level of tax-free components and a lower level of taxable components.
If your super balance consists of a high level of taxable components, a recontribution strategy can be used to replace them with tax-free components.
How Do Tax Components Come About?
When a contribution is made to your superannuation accumulation account and a tax deduction is not claimed (after-tax contribution) it forms part of ‘Tax Free’ component. Such contributions are referred to as Non-Concessional Contributions.
To work out the ‘Taxable Component’ of your superannuation balance, you simply add up all of the Non-Concessional Contributions that have been made to your account and deduct it from the total balance of your account. Whatever is left is considered the ‘Taxable Component’.
Let’s assume that you have a superannuation balance of $500,000.
Over the years, this account has received total combined Non-Concessional Contributions of $50,000.
Your balance would be as follows:
|Tax Free||$50 000|
|Total Balance||$500 000|
Why Do Tax Components Matter?
Ideally, you want your account to have a higher Tax Free Component than a Taxable Component for the following reasons:
1. If you pass away and your balance is paid to a non-dependent (e.g. child over 18), 15% death benefits tax will be payable on the Taxable Component
2. If you are under age 60, the Tax Free component is received tax free on any withdrawals – including income payments (assuming you can access your super); however the Taxable Component is assessable.
3. If there are future changes in legislation whereby the Taxable Component is once again taxed on withdrawal for those over aged 60, you will be better positioned if you have more of a Tax Free Component.
So, How Does a Recontribution Strategy Work?
Let’s go with the same balance stated above. A $500,000 super account made up of $450,000 Taxable and $50,000 Tax Free.
Our intention is to convert the Taxable component into a Tax Free component.
For the purposes of this, we will assume that you are over age 60, but under 65, and have met a full condition of release of your total benefits. Therefore, you should have the ability to withdraw your total balance tax free as a lump sum (check to make sure you don’t have any Taxable-Untaxed component – this may result in tax). We will also assume that you have not triggered the bring forward rule for Non Concessional Contributions in the previous two financial years and have not contributed more than $40,000 as a Non Concessional Contribution in the current financial year.
All withdrawals must be made proportionately. This means that we should not simply withdrawal the $450,000 Taxable Component and recontribute it, as this would contain part of the Tax Free Component and would leave part of the Taxable Component inside super and we would not be maximising the strategy. We must withdrawal the total $500,000 and recontribute it back in as a Non Concessional Contribution.
But What About the Non Concessional Contribution Cap?
The Non Concessional Contribution Cap is currently $180,000. However, you have the ability to ‘bring forward’ up to two more years’ worth of the cap if you are under age 65 – effectively allowing you to contribute up to $540,000. This cap is reducing to $100,000 as of 1 July 2017 and there are transitional arrangements for people who have triggered the Bring Forward Rule in either one of the 2015/16 or 2016/17 financial years. Read this article for more information.
The Result of the Recontribution Strategy?
As you can see, by withdrawing the total balance, which consisted of 90% Taxable component and re contributing it as a Non Concessional Contribution, we have transformed the total balance solely into Tax Free components. Based on this, it could save up to $67,500 in death benefits tax!
Use this calculator to calculate the benefits of a superannuation recontribution strategy on your balance.
What Are Some Things to Consider?
Here is a non-exhaustive list of some things you should consider prior to implementing a Recontribution Strategy:
1. If you have met a full condition of release but are under age 60, you may not be able to withdraw your total balance tax free. If this is you, please refer to the Lifetime Low Rate cap amount on the Taxable Component of lump sums here and seek advice from a professional.
2. If you have previously triggered the ‘bring forward rule‘ or made large Non Concessional Contributions in the current financial year, you may be at risk of exceeding the Non Concessional Contributions cap which can result in significant Excess Contributions tax.
3. If your balance is greater than $540,000, you will be unable to fully convert your balance solely into Tax Free components.
4. Withdrawing any amount from your superannuation may require the sale of assets which could incur Capital Gains Tax (CGT) and or investment transaction costs.
5. People over the age of 65 are unable to make Non Concessional Contributions to superannuation unless they are still working. Even then they are not able to utilise the ‘bring forward’ rule.