By Paul Trimble, Director, Westlawn Business Services 18 December 2013
If you have a taxable portion within your super fund, and most people do, using a withdrawal and re-contribution strategy can help ensure that you and your beneficiaries pay less tax on money from your self managed superannuation fund (SMSF).
Generally, your SMSF super benefit comprises two components:
1. The tax-free portion, which comes from after-tax personal non-concessional contributions you make over the years; and 2. The taxable portion, derived from concessional contributions you make over time. These include employer and salary sacrifice contributions.
Benefit payments are subject to a proportion rule, which requires them to be paid out in the same proportion as the tax-free and taxable components of your interest in the SMSF. For example, if your super benefit is 60% taxable and 40% tax-free, benefit payments must retain that proportion. Thus, if you withdraw a lump sum of $100,000, $60,000 is taxable and $40,000 is tax-free.
A withdrawal and re-contribution strategy involves withdrawing taxable and tax free benefits and re-contributing the money as a non-concessional, or after-tax, contribution. This increases the amount of tax-free funds within your super. This can mean significant tax savings if you’re younger than 60 years of age and major tax savings for your beneficiaries after your death.
The taxable component of pension income received by retirees under the age of 60 is taxed at the individual’s marginal tax rate less a 15% tax offset. Thus, by converting taxable benefits to the tax-free component, you can increase your tax-free pension income.
Upon the death of a fund member, the re-contribution strategy will benefit the beneficiaries, especially if the beneficiaries happen to be the children of the deceased who are older than 18 years.
Under typical circumstances, your super benefits — or those of your spouse — are likely to go to an adult child, who is not a taxation dependent. This means the taxable component is taxed at the flat 15% rate and subject to the 1.5% Medicare levy, for a total tax of 16.5%. The levy is expected to increase to 2% on 1 July 2014.
By withdrawing and re-contributing the majority of your taxable component, those adult child non-taxation dependents can receive a greater portion of death benefits without paying tax.
As an example, let’s assume you are 62 and have a super benefit of $450,000. The taxable component is $400,000. When you die, a non-taxation dependent, 30-year-old child receives the death benefit. That child will be taxed at 16.5% and pay $66,000 in taxes on the $400,000.
However, realising this, you decide to access your entire super benefit, providing you have satisfied a condition of release, and transfer it to your bank account. The withdrawal is tax-free because you are older than 60.
Two or three days later, you re-contribute the money to your super. Under what is known as the bring-forward rule, you can make a one-off contribution of as much as $450,000 in non-concessional contributions in a single financial year providing you are under the age of 65. This can be done as $300,000 in the first year and the balance of $150,000 over the following two years.
Contributing the money back into the SMSF creates no tax issues. Your super benefit is then tax free as your contributions now come solely from your onetime non-concessional contribution. When you die, your adult child will not be taxed on the benefit and will save $66,000 in taxes.
Keep in mind; you can use this strategy only if you have unrestricted access to your super and you are under 65 years of age. Also, if you withdraw money when you are younger than 60, you generally will have to pay tax on the taxable component.
While this strategy may optimise the tax-effectiveness of your pension income and benefit your beneficiaries, consult with your Westlawn Business Services Accountant to ensure it suits your specific circumstances.
Disclaimer Westlawn Business Services Pty Ltd provides this information for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers.
Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.