A look behind the re-contribution strategy (Part 2): Case studies

Liam Shorte and Richard Livingston take us through case studies that highlight the benefits and pitfalls of the re-contribution strategy.

In marginal tax rate (including Medicare Levy) minus a 15 per cent tax offset. If she had no other income, her tax bill would be around $900 a year (it would be a lot more if she had income from, say, a term deposit).

The re-contribution strategy is a simple way to reduce it. Let’s take a look at what Tina needs to do.

Tina has satisfied a condition of release, so she’s entitled to take a lump sum from her super account and – because her age is between 55 and 59 – she’s entitled to the bring forward rule’ to do it in one hit.

Once done, her super components change dramatically (see Table 1). If she goes ahead and converts the new accumulation account to a pension account, she can take two pensions totalling $60,000 but completely eliminate her tax bill. This simple strategy will save her roughly a thousand dollars each year but if she had a higher super balance, or other income, she would have saved a lot more.

Table 1: Impact of re-contribution strategy for Tina
  Before  After
Re-contribution Re-contribution
Original super account    
Taxable component (80%) 1,200,000 1,015,000
Tax-free component (20%) 300,000 253,750
Total balance 1,500,000 1,268,750
New super account    
Tax-free component (100%)   231,250
Combined super accounts    
Taxable component 1,200,000 1,015,000
Tax-free component 300,000 485,000
Total balance 1,500,000 1,500,000

The strategy also has the additional benefit of reducing the potential tax on any death benefits paid to adult children (or other non-death benefit dependants) if she were to pass away. Let’s now turn to a case study that deals with that example.

Reducing tax exposure on death benefits: David (age 62)

David is a retired 62 year old, with a super pension account totalling $2 million (like Tina’s, it also has an 80 per cent taxable component). He plans to complete a binding death benefit nomination instructing his super fund trustee to pay $1 million to his wife, Barbara and to split the remainder equally between his three children – aged 16, 20 and 24.

As things stand, a death benefit payment could go to Barbara and the 16 year old free of tax, as they are both ‘work test’) he’d be able to do more withdrawals and contributions. Depending on how often he is able to do this, his super account might end up almost entirely ‘tax-free’.

Reduced change of law risk

The other benefit Dave gets from this strategy is that the lower taxable balance should reduce his exposure to future super rule changes. For instance, let’s say the Government decided to impose a ‘pension tax’ on accounts with a taxable balance exceeding $1 million. By using the re-contribution strategy, Dave has reduced the ‘excess’ taxable amount from $600,000 to $24,000.

Shifting super to a younger spouse: Bob (age 66) and Linda (age 53)

Bob is a 64-year old retiree, married to Linda, age 53 (born April 1962), who still works full-time. Bob has $1.2 million in a super pension account and plans to apply for the age pension when he turns 65. Linda has $200,000 in her accumulation super account.

If they did nothing, the Assets Test would prevent Bob getting an age pension and Pensioner Concession Card (or the Commonwealth Seniors Health Card (CSHC)).Home-owning couples need to have less than $1,151,500 (based on current limits) in combined assets in order to collect a partial age pension.

Note: for the CSHC, couples must have an assessable income of less than $82,400. From 1 January 2015, income from account-based superannuation income streams is included in the CSHC income test.

But what if Bob withdraws $180,000 as a lump sum from his pension account and Linda uses the money to make a non-concessional contribution to her accumulation account?

The good news is that accumulation accounts belonging to a spouse who is too young to qualify for the age pension (below age 65 under the current rules) are exempt from the age pension Assets Test. After withdrawing $180,000, Bob’s pension account will fall to $1.02 million and (because Linda’s super account is excluded) this is the amount of their combined assets for the Assets Test.

The re-contribution strategy helps Bob qualify for the age pension and Pensioner Concession Card (PCC) when he would have otherwise missed out. Depending on his circumstances, his card use alone could be worth thousands of dollars each year. If Bob’s super balance was already low enough to qualify for a partial age pension, he could use the same strategy to increase the amount he’s entitled to.

Trade-offs with shift to a younger spouse

Unfortunately, this strategy isn’t always a ‘no-brainer’; there’s trade-offs involved. Linda now has $380,000 in her accumulation account, which is subject to 15 per cent tax (10 per cent on capital gains). In the current low interest rate environment, this is unlikely to add significant costs. If the additional $180,000 earns around 3 to 4 per cent income each year then the additional tax bill would be less than $1,000. But if Linda realised large capital gains before switching her account to pension mode (and note that some industry and retail super funds force you to do this) then the extra tax could be more substantial.

When Linda reaches her preservation age of 57 (based on her April 1962 birth date) she may decide she wants to switch her accumulation account to pension phase – either by starting a transition to retirement, or account based, pension. At this point, her account balance will be included in the Assets Test and Bob might lose his age pension.

For this reason, this strategy works better with much younger spouses, or where the couple is very close to qualifying for the age pension and the younger spouse has very little super. If Linda was 62 in our example, but had virtually no super, it might still be worth transferring the $180,000 to her and just leave it in accumulation until she becomes eligible for the age pension herself.

Finally, an additional benefit of using this strategy is that Bob has reduced his super balance and (like Dave above) this should reduce his exposure to future law changes, including taxes on large super balances. But on the downside, if preservation ages were increased, Linda might not be able to access her account for longer, so they’d have more money locked up in a taxable accumulation account.

Of course, the benefits of this strategy (and whether it’s of benefit at all) depend on the individual situation. For example, the need for Bob to withdraw a higher percentage from his super (to compensate for the lower balance), his use of the age pension benefits, Linda’s work status and their cash-flow needs will all affect the overall benefit achieved. For that reason, if you’re at all unsure seek personal advice.

Age pension grandfathering pitfalls

One of the potential pitfalls of this strategy is the loss of some or all your age pension if your super pension is ‘grandfathered’ from the age pension deeming rules, which started on 1 January 2015 (see Keeping your super grandfathered).

Let’s look at the example of Doris, a 66-year old retiree and age pension recipient, with a $235,000 super account. She takes the minimum super pension – $11,750 each year – but has no income for the age pension Income Test as the ‘deductible amount’ calculated under the old rules (see Age pensions and super income streams: Lifting the fog - Part 1) exceeds it.

Doris has one adult son and her super account has 100 per cent taxable components. If she were to pass away, the death benefit would be subject to around $40,000 in tax, so she decided to implement a re-contribution strategy similar to that which we outlined for David (above).

By withdrawing from her current super pension, contributing to a new accumulation account (which is entirely tax-free) and switching this to pension mode, she’s able to collect the same super pension but reduce the potential tax on any death benefit to zero.

But there’s a sting in the tail. The new super pension won’t be grandfathered from the age pension deeming rules. Doris will be ‘deemed’ to earn $7,405 for the purpose of the age pension Income Test (see calculation in Table 3), which will cost her around $1,350 of her age pension each year.

Table 3: Deemed income on super account of Doris
  Deemed
Income
First $48,000 (@ 1.75%) 840
Remaining $187,000 (@3.25%) 6,078
Total deemed income 6,918

There’s a choice for her to make: does she value the certain $1,350 each year, or the potential $40,000 tax saving on her death benefit more highly? Remember she also needs to account for the fact that, if interest rates move higher (increasing deeming rates) the impact on her age pension could be much greater.

Questions?

These case studies cover a number of real-life situations members are likely to face. But there will be other situations where the issues and trade-offs are more complex and the decision on whether to go ahead with a re-contribution strategy more difficult. If you are at all unsure, you should seek personal advice before proceeding and of course, if you have questions, use the Q&A function.

Richard Livingston and Liam Shorte are founders of Eviser.

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