Tax with Max: A dubious strategy

Question. I have $1.5 million in an SMSF with 90 per cent being taxable benefits. My financial adviser has suggested I establish a second SMSF and over the next 15 years withdraw the money from the first SMSF and contribute it into the second to reduce the inheritance tax to zero. This strategy would cost between approximately $15,000 and $20,000 over that period but would save approximately $225,000 in tax liability, with $45,000 in the first year alone. My partner and fellow trustee is in a similar situation. What are the implications of such a strategy?

Answer. The major implication that I can see of this strategy is that someone will be $15,000 to $20,000 better off and you will not save one cent in tax. What has been suggested to you is a classic re-contribution strategy that is designed to rechristen taxable benefits and convert them into tax-free benefits.

This strategy results in no tax benefit for the member of the SMSF, but instead is designed to reduce the amount of income tax paid by non-dependant beneficiaries that inherit the member's superannuation when they die.

I do not understand how your financial adviser has come up with savings of approximately $225,000, with $45,000 saved in the first year alone. The maximum tax paid by a non-dependent beneficiary receiving taxable super is 17 per cent. This means on a $100,000 withdrawal of taxable super from an SMSF, with $100,000 being re-contributed to a second SMSF, it results in a $17,000 potential tax saving to the beneficiaries in the first year.

Apart from the tax savings emerging from problematic mathematics, and you not really receiving a benefit, there are two major strategic problems with what has been recommended.

The first problem is a second SMSF is not even required. The strategy can work with just one SMSF. This would be achieved by the taxable superannuation being in pension phase and a $100,000 partial commutation lump sum being taken. The $100,000 is then re-contributed to the SMSF and an account-based pension started immediately. This results in two pension accounts in the SMSF, one with 90 per cent in taxable benefits and the other with 100 per cent in tax-free benefits.

The second major problem in relation to the strategy is that, in most cases, it could not be done over 15 years. To take lump sum payments from superannuation, the member must have met a condition of release. In this instant the retirement condition of release would be the most applicable.

To access the retirement condition of release a person must have reached preservation age and be working for less than 10 hours a week. The preservation age is 55 for anyone born before July 1,1960. For anyone born after that date it increases in yearly increments, so that the preservation age for someone born after June 30, 1964 is 60.

The re-contribution strategy can only be used by someone who is retired until they reach the age of 65. Theoretically someone could be 65 or older, and by passing the work test, could be using the re-contribution strategy. In most circumstances for someone who retired at age 55, and could not meet the work test, the maximum non-concessional super contributions they can make until they turn 65 are 17 contributions at the maximum non-concessional contribution limit.

The 17 contributions are made up of the yearly maximum contribution for each year until the person turned 65, at which point in their 65^th year they can use the two-year bring forward rule.

If you are 60 now, and cannot meet the work test once you turn 65, under the new non-concessional contribution limit of $100,000 the maximum amount you could re-contribute is $100,000 a year for the next four years. Then you could re-contribute $300,000 in your 65^th year. This, of course, would be dependent on your total superannuation balance being less than $1.6 million.

So the major implication of the strategy suggested by your current financial adviser is that you should be looking for a new one. The new financial adviser should be focused on producing tax and financial benefits for you rather than coming up with dubious strategies heavily weighted to making someone else wealthier.

Question. I believe that if a person has made only non-concessional contributions to the accumulation phase of a super fund, then those funds will be classed as the ‘tax-free component' of their fund. Consequently, for account-based pension purposes in the future, the pension will be tax-free even if the retiree is between 55 and 59 years of age. However, would the income-earned component, which was taxed at 15 per cent while in the accumulation phase, also be classed as a tax-free component when the account-based pension starts?

Answer. The calculation of the tax-free component of a superannuation fund member's account differs between an accumulation account and a pension account. Superannuation accounts in accumulation phase have the tax-free component shown as a dollar value. Superannuation accounts in pension phase have the tax-free component shown as a percentage of the value of the pension account.

This means a superannuation member who, during accumulation phase, only made non-concessional super contributions of $100,000 a year for 10 years, would have an accumulation account made up of $1 million in tax-free benefits. In addition, they would have a taxable component in their accumulation account made up of the income earned by the fund less the operating expenses and any tax payable on the income earned.

If the total accumulated after-tax income in the member's account was $150,000 at the time they retired at age 57, their superannuation would be made up of $150,000 in taxable superannuation benefits and $1 million in tax-free non-concessional benefits.

Once an account-based pension is commenced from the total superannuation balance of $1,150,000, the tax-free component of the pension account would be 87 per cent, with the taxable component being 13 per cent. If the income generated by the superannuation fund exceeded its running costs and the account-based pension payments, and the fund increased in value to $1.2 million, the tax-free component would remain at 87 per cent with the tax-free value growing to $1,044,000.

The good news for the 57-year-old is that no tax could be payable on the taxable portion of the account-based pension received. This is due to the 15 per cent income tax offset that applies to taxable superannuation pensions received for someone who is under 60. This means for someone that has no other income, after taking into account the 15 per cent tax offset, they could receive an account-based pension of approximately $48,000 and not pay any income tax.