Considerations and opportunities in recontribution strategies
A staple of retirement planning advice, the recontribution strategy has seen a resurgence in popularity since the work test was removed from super contributions law effective 1 July 2022.
This change has paved the way for individuals who are under 75 to make contributions to super regardless of their working status, subject to their total super balance.
Given its resurrection, this article will revisit the core strategy as well as revisit a few of the common considerations that advisers and clients should have when dusting off the strategy.
What makes the strategy tick?
At its heart, a recontribution strategy has two main elements:
- A cashing of a lump sum from accrued superannuation benefits; and
- A subsequent contribution back into superannuation, generally as a personal contribution.
Nowadays the strategy is generally undertaken to reduce the taxable component of a client’s super benefit, with the aim of reducing the tax paid by non-tax dependants for any funds which remain when the client passes away.
However, it can also be used to shift super capital between members of a couple to take advantage of any unused transfer balance cap or to shield assets from Centrelink means testing if the younger spouse is under Age Pension age.
Example
Pam is 65 and is still working but wants to minimise the tax her adult children will pay on receiving her super when she passes away. Her current balance is $1 million, which is 90 per cent taxable component.
Her adviser recommends a lump sum withdrawal of $440,000 from her super in June 2023, with a $110,000 personal non-concessional contribution to be made before the end of the 2023 financial year, and a $330,000 personal non-concessional contribution made in the next financial year.
As Pam is over 60, the withdrawals from her super do not incur any personal taxes, however post the implementation of the strategy the underlying components of her benefit have changed, as follows:
| Existing benefit | Withdrawal | Post strategy benefit | |
| Tax-free component | $100,000 | $44,000 | $496,000 |
| Taxable component | $900,000 | $396,000 | $504,000 |
| Total balance | $1,000,000 | $440,000 | $1,000,000 |
This results in a reduction in the taxable component of $396,000 (i.e. the taxable component of the withdrawal). If Pam were to pass away just after the strategy was implemented, her adult children beneficiaries would save $67,320 including Medicare Levy (i.e. 17 per cent of $396,000) in tax due to this reduction in taxable component.
Where can things go wrong?
Although on paper the strategy seems simple, there are three common areas where we have seen some misunderstandings.
The first is in ‘journaling’ transactions. Journaling is the practice of noting the withdrawal and contribution in the records of the super fund without any payments being facilitated. We have seen this adopted by some SMSFs with large illiquid assets who still wish to take advantage of a recontribution strategy.
However ATO Interpretive Decision 2015/23 makes it clear that a benefit cannot be ‘cashed’ under Part 6 of the SIS Regulations 1994 simply by way of journaling the transactions. Whilst the decision relates to death benefits, the reasons provided apply equally to cashing of member benefits - the capital must leave the superannuation fund. This can be facilitated by an in-specie transfer of investments – but the investments must leave the fund.
Similarly, Tax Ruling 2010/1 discusses when a contribution is made to a super fund. One of the key requirements for a contribution to be made is that the capital of the fund must be increased.
The combined effect of these rulings confirms that journaling a recontribution strategy would fall short
on both payment and contribution transactions.
However, there does not appear to be a ‘minimum time’ the funds must leave the fund to be considered a valid withdrawal and recontribution. For example the ATO successfully argued that a withdrawal and recontribution which occurred on the same day via an in-specie transfer of assets between a SuperWrap and IDPS was a valid recontribution in Pitts v Federal Commissioner of Taxation [2017] AATA 685.
The second misunderstanding is around how a withdrawal impacts a client’s total super balance (TSB). TSB is calculated each year, based on values at 30 June and applies for the following financial year.
Importantly, a withdrawal made during the financial year does not impact the TSB for that same financial year. However, if the funds are withdrawn (and recontributed) before 30 June this may result in a lower TSB for the following financial year. This can allow for a greater personal non-concessional contribution than if the withdrawal was actioned after the TSB is calculated.
This does mean capital may remain outside the super fund for a longer period, and if implemented via an in-specie transfer of investments may result in 30 June distributions being paid to the client themselves rather than being received by the super fund.
The third consideration relates to the benefit of creating a separate super interest to receive the contribution. If the recontribution strategy is to be implemented over multiple withdrawals and contributions, isolating the tax-free contribution into its own interest can optimise the effectiveness of the strategy compared to using the same interest. This is because any subsequent withdrawals will include part of the recontributed tax-free component.
For example, consider a client with a $800,000 completely taxable component. By implementing a two-stage withdrawal and recontribution of $330,000 this financial year, with a view to do a second $330,000 recontribution after this bring-forward expires. For simplicity we will ignore investment earnings and indexation.
If the one account is used for both transactions, the end tax-free component is expected to be $523,875, compared to $660,000 if making the contributions to a separate interest. This could result in over $20,000 of tax saved in the hands of non-tax dependent beneficiaries. However, this could increase administration costs and complexity in managing the client’s balances.
There’s no express ‘wrong answer’ in using one account or two but rather a trade-off between potentially increased effectiveness of the strategy, against complexity and potential increase costs.
Overall, implementing a recontribution strategy can be an effective retirement and estate planning
consideration for clients. However, it is important to keep in mind the process used to implement the
strategy to ensure it is both effective and optimised.
Josh Rundmann is senior technical services manager at Insignia Financial.
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