Leave your kids with a smaller tax bill

SMSF technical expert and columnist for The Australian newspaper
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The reason for taking more than one pension is nearly always based around potential estate tax advantages. It’s very easy to focus solely on the tax benefits and forget that running more than one pension will nearly always cost more money to administer. But for some, a multiple pension strategy may have benefits.

So what is a multiple pension strategy and is it something that will work for you?

Background

Five years ago it often made good sense for a retiree to run two pensions. This is because before the 2007 Better Super changes you could more easily control the tax paid on lump sum withdrawals prior to death from multiple pensions. Many years before 2007 there were even some additional Centrelink – or Department of Social Security as it was known back then – benefits available from running more than one pension.

A major change of the Better Super regime did away with your ability to choose the tax components of lump sum withdrawals. Now days, when a pension commences, the Taxable and Tax-free Components are worked out at that point and then never change (read, How your pension influences tax on death benefits).

Another major change made under the Better Super amendments was to deny adult non-dependent children the ability to take a pension with their parents’ super death benefit. More to the point, these children have to pay 16.5% on the Taxable Component of any lump sum death benefit paid to them.

These three issues sometimes demand restructuring a person’s super accounts and the taking of multiple pensions. This is best explained by an example.

How multiple pensions work

Suppose your aged 64 and are about to retire with $1 million in your super, which is all in the Taxable Component. You need $50,000 per year income to live and so you decide you need the entire $1 million to deliver you that income.

At this point in time, because you’re under 65, you have the ability to use the bring forward Non-Concessional Contribution strategy – that is, the ability to make three years’ worth of contributions ($450,000) at once. Let’s assume that you haven’t used this strategy to date.

You have indicated that in the event of your death you would like your spouse to receive 50% of your account balance as a pension, with the remainder to be paid to your adult non-dependent children.

At present the $500,000 payable to your children would face 16.5% tax or $82,500 whilst the pension paid to your spouse would be paid to them tax free. Using a multiple pension strategy, you can reduce the amount of tax your children will have to pay.

The strategy works like this: After permanently retiring, you take out $450,000 as a lump sum withdrawal, which is tax-free because you are over 60 years of age. You’re taking out $450,000 because you want to ultimately contribute this money back into your super using the bring forward rule, and this is the maximum non-concessional contribution you can make.

With the $550,000 left in your fund, you commence a pension with using $500,000 of which you take $25,000 in income. This pension will be a 100% Taxable Component. At the commencement of this pension you nominate your spouse as a reversionary so that in the event of your death, the pension continues to be paid to them.

You then use the three-year bring forward non-concessional contribution rule to contribute the $450,000 lump sum payment back into your super.

With the $500,000 account balance ($450,000 plus the remaining $50,000 in the fund) you commence a second pension which will be 90% Tax-free ($450,000 = 90% of $500,000). As noted, this percentage will not change.

From this second pension, you take $25,000 in income, pushing your combined pension income up to $50,000.

On the second pension, you use a Binding Death Benefit Nomination in favour of your adult children. Any lump sum death benefit paid to them will be from the 90% Tax-free Component. If the death benefit is $500,000, then only 10%, or $50,000 will be taxed at 16.5%, meaning the tax payable is only $8,250 compared with $82,500 without the strategy.

Will it suit you?

In my view, this is the only reason you might consider taking multiple pensions in the current legislative environment. A major consideration before implementing this strategy is the cost of putting the structure into place and the additional ongoing administration charges.

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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