Save tax with a re-contribution strategy

SMSF technical expert and columnist for The Australian newspaper
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The “withdraw and re-contribution” is a strategy designed to save tax and involves you taking money out of super as a lump sum and then after a period of time re-contributing this payment back into super.

This strategy first became popular in the mid 1990s and between 1995 and June 2007 was almost standard fare for most investors preparing for retirement.

Costello’s “Better Super” reforms reduced the instant tax benefits on this transaction in many cases but it still delivers important estate planning tax concessions. It might also have a short-term tax benefit for anyone aged at least 55 but under 60 and fully retired.

Estate planning benefits

This is best explained by an example.

You’re aged 63 and have $1 million in super, which is all taxable component. Your spouse is 62 and has no super assets in their name. An important consideration for you both is the amount of tax your surviving adult children might pay on you and your spouse’s death.

At present, your adult independent children would have to pay almost $165,000 tax on a $1 million death benefit (that is 16.5% tax).

So should you take $450,000 out of your super benefits now and contribute it in your spouse’s name as a non-concessional contribution and then perform a similar transaction in your own name at a later date?

These contributions will only be possible while you’re under 65 and you have no excess non-concessional contribution problems. You can only take this money out of super if you’re fully retired. After you turn 65, the $450,000 threshold, in general, becomes unavailable.

Once you take the money out of your super and make the non-concessional contribution for your spouse, those contributions will become a 100% tax-free component, which can be used to provide a pension. The pension can only commence once your spouse is fully retired or reaches age 65. But after the pension commences, it will remain 100% tax-free for the remainder of your spouse’s life. This will include benefits payable on death.

After the withdrawal and re-contribution strategy, your super benefits will be $450,000 tax-free component and $100,000 taxable component. Your spouse’s portion will all be tax-free component ($450,000).

To look at your super in its totality, 90% of your and your spouse’s super assets are now tax-free component.

Tax on death (payable by an adult child) is now down to $16,500, which is a significant saving for completing a few comparatively simple transactions.

Short-term tax benefit

For those aged at least 55 but under 60, the taxable component portion of their pension payments are taxed with a 15% rebate. A higher tax-free component brought about because of the “withdraw and re-contribute” strategy will mean less taxable component with each pension payment and, therefore, potentially less income tax to pay.

Given the impact of the 15% rebate – and the fact that it significantly increases your effective tax-free threshold to about $49,000 – this will only impact a small number of taxpayers.

Some clarity

For many years it wasn’t known if “withdraw and re-contribution” transactions were acceptable because nothing formal had ever been published. Over the years, the industry and retirees have relied on Tax Office press releases and letters between government bureaucrats and industry associations on how the law operates.

This is a completely unsatisfactory situation for a transaction that impacts so many taxpayers.

Earlier this year, the ATO published a Private Binding Ruling (PBR) about the “withdraw and re-contribution” strategy.

The PBR says the taxpayer in question was aged over 55 and was thinking of retiring because of an illness that had lasted more than 12 months.

Because of their illness, they asked to get their super money paid to them as a lump sum but then realised they’d get less disability pension from the government.

In the PBR, the Tax Office had no issue with the lump sum paid to the taxpayer. The ATO acknowledged that the member had a right to ask for the benefit and the super fund’s trustee was entitled to pay them the benefit.

The ruling was indifferent about the making of the contribution with those withdrawn super benefits. The PBR doesn’t say a period of time has to pass before the contribution could be made with the withdrawn super benefits.

In the absence of clearer instruction from the Tax Office, this ruling provides the best evidence to date that the ATO is comfortable with this tax-saving strategy.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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