STRATEGY
The rewards of recontributions Withdrawal and recontribution strategies can result in achieving better tax outcomes for SMSF members and their death beneficiaries. Craig Day illustrates how this can be achieved in more than one way. The recontribution strategy is a common strategy used by financial advisers for many years to reduce the tax on lump sum death benefits paid to non-tax dependants. However, there are a range of SMSF specific issues that need to be thought through before implementing any recontribution strategy, including whether it even makes sense to do so.
What is the recontribution strategy? CRAIG DAY is head of technical services at Colonial First State.
The recontribution strategy in its most basic form involves a member withdrawing a tax-free lump sum from superannuation and then recontributing back into super. The traditional aim of this strategy is to convert a taxable component into a tax-free component by cashing out lump sums that consist either partly or fully of a taxable component and then recontributing that amount as a non-concessional contribution (NCC), which then counts towards the tax-free component. For example, a member over the age of 60 with a benefit made up entirely of taxable component could potentially save up to $17,000 in death benefit tax per $100,000 of lump sum death benefit paid to a non-tax dependant by implementing the strategy.
Recontribution quirks for SMSFs While a simple one-off recontribution works fine in an SMSF, things can get a little more complicated where the amount the client wishes to cash out and recontribute exceeds their NCC cap under the bring-forward rule, as this may require the client to recontribute several times over a number of years. In this case, without a proper understanding of the rules and a little bit of strategy, an SMSF client may not get the outcome they were totally expecting. For example, while most people implement the recontribution strategy after 60 to ensure the lump sum will be tax-free, it’s important to remember the proportioning rules still apply to require the
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lump sum to be broken up into its constituent tax components. As stipulated in section 307-125 of the Income Tax Assessment Act 1997 (ITAA), this is done by applying the same tax component proportions to the lump sum as the super interest they are drawn from. For example, a $10,000 lump sum withdrawn from an interest made up of a 30 per cent tax-free and 70 per cent taxable component would consist of $3000 tax-free and $7000 taxable components. This means with each subsequent recontribution, the following withdrawal will be made up of increasing amounts of tax-free component, thus increasing the number of transactions and time it would take to fully convert a taxable component to a tax-free component via this strategy.
Case study Andrew, a retired divorcee, turns 65 on 8 August 2022 and has $550,000 in an SMSF that is 100 per cent taxable. He has nominated his non-financially dependent adult daughter, Sabrina, to receive his death benefit via a binding death benefit nomination. If Andrew were to pass away, his death benefit would be subject to tax of up to $93,500 (that is, $550,000 x 17%). If Andrew implemented a recontribution strategy under the current rules, he could make three withdrawals across a period of three financial years, recontributing the funds back into superannuation each time as NCCs. This would be comprised of a $110,000 contribution in 2022/23 and 2023/24, and then a $330,000 contribution triggering the bring-forward provision in 2024/25 when he reaches age 67. However, if Andrew recontributed back into his SMSF, a significant portion of his superannuation balance would remain as a taxable component when he turned 67 due to each withdrawal being made up of increasing amounts of tax-free component due to
