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Written by Hudson Adviser Ivan Fletcher.
This is a strategy whereby you withdraw a large Lump Sum from heavily weighted ‘Taxable’ component in your existing super/ pension balance and contribute back to super as a ‘Tax Free’ component. The criteria for qualifying for this strategy are quite stringent and as such is not available to all. It is particularly relevant but not exclusive to young retirees (55 to 65) and older retirees (over age 65) who still satisfy the work test.
This has the effect of reducing ‘taxable’ components associated with your previous ‘concessional’ based contributions and will ultimately increase the tax effectiveness (including estate planning) of your super and/or pension accounts.
Window of opportunity before 30 June 2017
This has become a more viable strategy as a result of the latest legislation changes.
Whilst this strategy is viable every year, the reduction in Contribution limits (CAPS) effective 1 July 2017, means there is a limited opportunity for maximum potency by utilising the current more generous Contribution CAPS before 30 June 2017.
This provides three levels of potential long term tax protection:
- Under Age 60 – If you are starting a Pension before age 60, it will reduce the tax assessable amount of your pension.
- Over Age 60 – Increases protection against potential legislation changes – should the government (current or future) introduce a tax on pension incomes for the ‘taxable’ component as currently is the case for persons under age 60.
- Death Benefits – In the event your Superannuation assets are left to tax non-dependants (e.g. adult children), it will reduce the taxation impact. Currently ‘non-tax dependants’ are subject to 15% tax + Medicare Levy on the ‘Taxable Component’.
- If using the 3 year provision, it may preclude you from further contributions from the sale of other assets or windfall gains such as an inheritance. In some cases you may be better served by keeping the 3 year provision up your sleeve to allow NEW funds to be transferred into your super.
- Historically, there has been one significant disadvantage of this strategy – which was the potential for the beneficiary (especially a spouse) to lose some of their ‘Anti-Detriment benefit’ entitlement as a Lump Sum beneficiary.
Legislation Change – The anti-detriment benefits have now been scrapped when the new legislation takes effect on 1 July 2017 which removes this disadvantage overnight on 1 July 2017.
Anti-detriment Payments – Explained,
Anti-detriment benefits represent the partial refunding of contributions tax paid over time in the event of death. This payment represents an additional payment (bonus if you like) above your actual pension balance at the time of death. It is payable only on the ‘Taxable’ component of your super or pension if taken in a Lump Sum format.
The amount would be somewhere between 14.65% and 17.65% of your taxable component. Using an indicative rate of 16% this Bonus benefit was significant.
Example if you have a $300,000 taxable component in your super/pension, a spouse beneficiary could receive an additional payment of $48,000 (16% x $300,000). Historically, this created a significant disincentive for a re-contribution strategy.
Example Of Savings To Your Estate Beneficiaries
The Ultimate Beneficiary
If your spouse is your nominated beneficiary, they are considered a ‘tax dependant’ and will not be subject to taxation regardless of the components (under current legislation). It is also quite likely (especially if you are already retired) that your spouse would elect to keep the monies in Super or Pension for the long term tax benefits and thus the “Taxable Components live on.
This means a surviving spouse would then nominate new beneficiaries. Ultimately your eventual beneficiary is more likely to be a ‘non-tax dependant’ (example adult children or some other relative or friend), which means that eventually tax will apply to your taxable Component (one day).
However should you and/or your spouse enjoy a long and healthy retirement and utilise all of the funds or withdraw them before both of you have passed, there is no tax issue for your estate planning.
Example of Tax
A $400,000 super/pension balance with 80% of that ($320,000) as a taxable component would result in tax (in the hands of a non-tax dependant) of $54,400 (15% + Medicare levy 2%).
However if withdrawn and Recontributed (using the 3 year provisions) under a re-contribution strategy, this would then reclassify the $320,000 as ‘tax Free’ saving your long term beneficiaries that tax of $54,400.
If you qualified for only a $180,000 (1 year) contribution then you could still alter the tax free amount for $180,000 x 80% ($144,000) and thus potential tax saving of $24,480 (17%) for your long term Beneficiaries.
So Do You Qualify to Implement this Strategy?
Sounds simple but there are several criteria to be met to qualify for this strategy to be available and beneficial (tax wise).
Criteria 1 – Preservation Release
The main condition is accessing your Super/Pension to effect a withdrawal. For this we need to refer to the preservation components of which there are 3 classifications:
Unrestricted non-preserved – which are fully accessible;
Restricted non-preserved – which can be accessed if you have terminated employment with an employer who has contributed to that fund.
Preserved – which can only be reclassified as Unrestricted non-preserved and accessed if you meet one of the three conditions of release – listed as follows :
- You are Age 65 or older; or
- You are aged 60 to 64 and have ceased a gainful employment arrangement since turning 60; or
- You are aged between preservation age and age 64 and have permanently retired and do not intend to ever work again 10 hours or more per week. This option requires that you have previously terminated some form of employment in your life (at any age).
Criteria 2 – Tax Considerations
Age 60 or above
No tax is payable on Lump Sum withdrawals and therefore no limit on the amount you can withdraw from Super tax free.
Under age 60, tax is applicable
There is a ‘Low Rate Cap’ allowing some tax free access. The first $195,000 taken as a Lump Sum from the ‘taxable component’ of Superannuation (before age 60) is tax free if taken from a ‘Taxed element’. Anything above this level is taxed at 15%. This is a lifetime limit and therefore would include any previous lump sum payouts from super in your lifetime (that would also form part of this $195,000 limit).
Caution: Please note that Pension payments are not included in the ‘Low rate Cap’ and are treated very differently to Lump Sum payments for tax purposes. If withdrawing from Super or Pension under the age of 60, this needs to be carefully managed. Once you have exhausted the ‘Low Rate Cap’ of LUMP SUM withdrawals, taxation impact will start to outweigh the advantages of this strategy.
WARNING: If you have an “Untaxed Element’ there is no tax free level and you will be taxed between 15% and 45% depending upon the level of your withdrawal making this strategy unviable.
Criteria 3 – Contribution Limitations (Non-Concessional)
An essential part of this strategy is to be able to contribute the funds back into super via personal non-concessional contributions.
These are personal after-tax contributions. There is no contributions tax applied to non-concessional contributions. The maximum amount for this category is $180,000 for this financial year (2016/17)
Caution if Over Age 65 – You cannot make a contribution unless you have satisfied the Work Test of working 40 hours within a 30 day period.
Bring forward provision: $540,000 over 3 years
A three year aggregation rule applies (under age 65 only) to allow you to contribute above the annual amount.
- Persons under age 65 at any time during the financial year may effectively bring forward two years worth of non-concessional contributions, allowing them to contribute up to $540,000 in one transaction. This would of course mean you would not be able to contribute to super again for the following two years.
Changes for Next Year 2017/18
As of 1 July 2017, the non-concessional contribution limit will be reduced to $100,000 per annum and therefore $300,000 under the 3 year bring forward provision. This provides for a far greater opportunity if this can be exercised in the current financial year.
Tip : You can make the re-contribution to your spouse or yourself or a combination of both which may provide other benefits such as a levelling of balances between you.
WARNING – CONSEQUENCE OF CONTRIBUTION CAP BREACH
If you do breach the non-concessional Cap then you will be liable to pay the maximum tax of 49% (including Medicare Levy) on the excess contribution. This is a significant penalty. Therefore if you are utilising the 3 Year rule, it is imperative that your check (with the ATO and your Super funds) that:
1. You have no other payments to super funds or insurance companies that could count as a non-concessional contribution this financial year 2016/17 and thus counting towards the 3 year Cap of $540,000.
2. You have not previously triggered the 3 year bring forward provision by contributing more than $180,000 to super in your name in the financial years 2014/15 or 2015/16.
3. You have not breached your ‘Concessional Cap’ in this year or the previous two years, as any excess will be allocated as ‘non-concessional contributions.
If unsure it can be a good idea to leave some space and contribute only $175,000 or $500,000 using the 3 year rule, to allow for some room for error in your calculations, better still consult with the ATO, your super fund and your adviser.
FINAL WORD – SEEK ADVICE
This strategy can provide significant tax sheltering for your estate planning where the ultimate beneficiaries (past beyond the death of both you and your spouse) is going to be a non tax dependant’ such as adult children.
This strategy is complex and will have some form of cost and also with potentially significant tax penalties should your falter and should not be attempted without consulting your adviser. This strategy is viable in any financial year, however due to the legislation changes effective 1 July, the opportunities are far greater this financial year.
This article is for educational purposes only and cannot be taken as personal advice. It does not take into account any individual’s objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each individual’s circumstances. You should consult with a financial adviser to discuss your personal situation.