One of the fundamental changes made to superannuation under the new system was to reduce the many components of superannuation to just two, those being taxable benefits and tax-free benefits. This re-contribution strategy aims to increase the tax-free benefits percentage to provide a tax benefit upon the death of the member.
Taxable super benefits paid to a non-dependant are taxed at 17 per cent including the Medicare levy. Under this strategy a super fund member takes a lump-sum tax-free payment after turning 60. This lump sum is then re-contributed to the super fund as a non-concessional contribution. An account-based pension is then commenced that locks in the tax-free percentage of the member's benefits.
When the member dies any residual superannuation benefits passing to non-dependants are received by them tax free. The limit on how much a person can make a year in non-concessional contributions restricts the amount that can be withdrawn and re-contributed.
Example of how the strategy works
Agatha Marple had commenced an account-based pension after taking a lump sum of $195,000 and re-contributing it. Under Agatha's will her whole estate is to go to her adult nephew. If she does nothing, and upon her death she has $100,000 left in superannuation benefits, 67.5 per cent of the $100,000 passing to the nephew and would be taxed at 17 per cent.
Agatha is aware of the tax consequences of her doing nothing and decides at the age of 63 in May 2017 to withdraw all of her super as a lump sum of $500,000. To do this she must commute her account-based pension then take the lump sum.
This lump sum is then re-contributed back to her SMSF as a non-concessional contribution of $500,000 before 30 June. Once this is done her super fund will be made up of 100 per cent of tax free super benefits.
If Agatha immediately starts another account-based pension that is still being paid at the time she dies, her super benefits remain at 100 per cent tax-free. If Agatha died while still having $100,000 in superannuation, her nephew will now pay tax no tax on what he receives, a tax saving of $11,475.
Documentation and Actions Required
If a member is in pension phase prior to implementing this strategy a letter needs to be sent to the trustees requesting that their pension be commuted back to accumulation phase. If investments must be sold to fund the lump sum these should be sold while still in pension phase to minimise any capital gains tax payable.
Letter from member to trustee/s of SMSF that they have met condition of release and that they want a lump sum payment. The value of the lump sum payment will be limited to the amount that can be contributed as a non-concessional contribution. Currently this $540,000 applies if the member has not exceeded the $180,000 non-concessional contribution cap in the previous three years and they are under 65.
Resolution by trustee/s stating request for lump sum has been received and that payment will be made.
Letter from trustee/s to member advising of payment of requested lump sum.
If maximum non-concessional contribution is to be made after July 1, 2017 $100,000 must be contributed before 30 June in the year the lump sum is taken, and then $300,000 contributed after July 1 for the next financial year and then no more contributions for the two following financial years.
Letter from member enclosing second non-concessional contribution and requesting that an account based pension commence.
Resolution by trustee/s acknowledging receipt of non-concessional contribution and stating request for an account based pension has been approved.
Letter from trustee/s to member advising that account based pension will be paid and its components.
Trustee/s complete ATO documentation to register for PAYG withholding tax.
Trustees calculate PAYG withholding tax to be deducted and set up regular payments direct from SMSF bank account.
If PAYG withholding tax has been deducted once a quarter trustee/s complete PAYG withholding statement paying amount withheld to ATO.
Some experts have raised the concern with this strategy that it may be attacked by the ATO under Part IVA. For Part IVA to apply, a taxpayer must have entered into a scheme or arrangement where the primary motivation is to gain a tax benefit. In this case the person taking the lump sum then re-contributing it does not receive the benefit, his or her heirs do. Before implementing this, and the re-contribution strategy for people under 60, you should seek professional advice.
The amount that can be re-contributed as a non-concessional contribution cannot exceed the limits set. Currently if you are under 65 they are $180,000 a year or, if you have not exceeded this limit in the previous three years, you can contribute up to $540,000. If you are over 64, under 75, and meet the work test, the limit is $180,000 a year. These limits decrease to $100,000 a year and $300,000 from July 1, 2017.
Before using this strategy you should seek professional advice as to whether you will actually benefit from following the strategy and will not end up worse off if the strategy does not really apply to you.