Summary: Recontribution strategy users will be the real victims of a retrospective $500k non-concessional contribution limit.
Key take-out: Those using or considering a superannuation recontribution strategy will need to consider their timing, and whether it can be justified.
Key beneficiaries: Superannuation accountholders and SMSF trustees. Category: Superannuation.
The final hard sell on the government’s proposed superannuation overhaul started on Monday in Canberra.
Politicians started returning to Canberra, and Prime Minister Malcolm Turnbull and Treasurer Scott Morrison were continuing to sell the message that they don’t believe changes to its announced superannuation package are necessary.
With no agreement, we have little chance of seeing draft legislation any time soon. And the detail will be critical.
It’s still all about the proposed $500k lifetime non-concessional contributions limit (see my column from last week, Morrison's struggles may spur super changes). Coalition backbenchers want it lifted to a $750k limit and preferably not backdated to 2007. It appears Labor would support $500k, so long as it is not backdated.
The best example of how this change is, actually, retrospective comes from the impact it would have on those who have used recontribution strategies in the past.
What is a recontribution strategy?
A recontribution strategy is, as the name suggests, a strategy where money is taken out of superannuation, then recontributed back into the fund.
Why? This has traditionally been done for two reasons. The first, to reduce the tax payable on a super pension paid to someone under age 60. The second, to reduce tax payable to beneficiaries. For a longer article on the strategy, (see my column Reconsidering recontributions).
If you draw the money out of superannuation, it comes out proportionally to the make-up of the existing funds.
But let’s assume that Mary had a $500,000 super fund, made up solely of concessional contributions (the 9.5 per cent superannuation guarantee). Mary is 62, has just permanently retired, is divorced with adult children.
If she were to die now, her adult children would lose up to 17 per cent of the $500,000 before they receive it. That is, tax of up to $65,000. (If there were any “taxable untaxed” amounts, such as what is in many government defined benefit scheme funds, the amounts could be taxed at up to 32 per cent.)
Good advice in the past might have been to take the $500,000 out of super, then recontribute it back into super, using the $180,000 non-concessional contribution caps, combined with the three-year pull forward rule.
If this was done, the kids would potentially pay $0 in tax if she were to die, as all of the money is now tax-free.
So, yes, the strategy was justified. And her children might benefit from this (or not, if she lived long enough to use up all of her pension), though less and less the older that she lives and draws down on the pension fund.
But she will now be stung by the new rules (as unforeseeable as they were). She has finished work, but even if she had some other property/investments outside of super, she is unlikely to be able to get them in, unless it makes sense for her to continue to make the $25,000 concessional contributions that will be available up to age 74.
In my opinion, this is where these changes are truly retrospective. In this example, based on the laws of the day, she turned a super balance of $500,000 made up of essentially CCs, into one made up of NCCs.
The contributions were not designed to cut Mary’s own tax, as she was over 60 and wouldn’t pay tax in any case. And the amount of money that it would eventually save her children, should she draw on her pension fund and live to the average age, might actually be zero, or not much at all.
It was a legitimate strategy - that might well cost her now, particularly if she had the opportunity to make further NCCs before turning 65 (under the current rules) and up to age 74 (under the proposed rules).
Unless she is earning, outside of super, a considerable income, there might be no value in making the $25,000 concessional contributions that would be available to her, up to age 74.
Is recontribution as a strategy dead?
The answer, if the government’s proposals get up, is not completely. But it almost will be, as it will become harder and harder to justify. And, in many cases, it won’t be worth taking the risk.
In fact, making NCCs too early in life are going to require very careful consideration. In the case above, it’s not likely to be a strategy to consider unless it was highly unlikely that further contributions to super were going to be possible.
For several reasons, delaying making NCCs might be important.
- If there’s a chance that you’ll get a reasonable inheritance before turning 75, then keeping some of your cap open might be a good option.
- Those still working and making CCs might want to hold back until after they have more than $500,000 as a total super balance. Those with more than $500,000 in super will lose the ability to use the five-year catch-up provisions on CCs.
- For anyone with geared property outside super, who might want to be able to sell a property later in life and contribute money to super.
The downside of not putting money into super earlier, of course, is losing the low-tax, and compounding, nature of those funds earning in the super environment. But, particularly with negatively geared properties, there might be more benefit in having that money invested outside of super.
Those who have recently used recontribution strategies, however, face a bigger problem. It’s one that’s not overly forseeable, but it will cost those who put some careful planning into their super.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.
Bruce Brammall is a licensed financial advisor, a mortgage broker and an expert on self-managed super funds. He is a regular contributor to Eureka Report. To contact Bruce, please click here.