In recent years, a significant shift has occurred in the Australian superannuation landscape, particularly among older Australians. A strategy known as the superannuation recontribution strategy has gained considerable traction, especially after the 2022 legislative changes that removed the work test for people aged 67 to 75. This change has not only broadened opportunities for tax-efficient retirement planning but has also introduced a potential avenue for creating tax-free inheritances for beneficiaries.
As clients look to optimise their superannuation in light of these changes, understanding the mechanics of the recontribution strategy, its implications, and the associated benefits is crucial, particularly when considering estate planning.
What is a Superannuation Recontribution Strategy?
At its core, the recontribution strategy involves withdrawing a lump sum from a superannuation fund and then re-depositing that sum back into the fund as a non-concessional (after-tax) contribution. While the strategy doesn’t directly benefit the super fund holder in terms of tax relief or additional growth, it significantly benefits the superannuation beneficiaries—often adult children—by reducing or eliminating the tax payable on the inherited super.
The tax benefit arises because superannuation inheritances are typically subject to a 15% tax on the taxable component of the super balance. However, if the taxable component is washed away through recontribution, it can potentially result in a tax-free inheritance for the beneficiary, offering substantial savings for families looking to pass on wealth.
The Impact of 2022 Legislative Changes
Before July 2022, Australians aged 67 to 75 were unable to make non-concessional super contributions unless they met the work test. The work test required individuals to work at least 40 hours over a 30-day period during the financial year to make these contributions.
With the removal of this work test, Australians aged 67 to 75 can now make non-concessional contributions regardless of their employment status. This change has sparked a noticeable rise in recontribution strategies, particularly among retirees and those who are financially independent and intend to leave an inheritance.
The Potential Benefits of the Recontribution Strategy
The primary appeal of the recontribution strategy lies in its potential to turn taxable superannuation into tax-free super when inherited. Superannuation contributions are generally taxed at 15%, with earnings in the accumulation phase also subject to this tax rate. The taxable component comprises employer contributions, salary sacrifice contributions, and personal voluntary contributions for which a tax deduction has been claimed.
By withdrawing and recontributing the super balance as non-concessional contributions, the taxable component can be transformed into a tax-free component. This is particularly advantageous if clients intend to leave a substantial super balance for their beneficiaries, as it ensures a higher inheritance amount with minimal tax obligations.
For instance, if you have a super balance of $1.8 million that is largely made up of taxable components, their beneficiaries could face a tax bill of approximately $270,000 (15% of the taxable portion) if the strategy is not implemented. However, by following a recontribution strategy over several years, a client could reduce the taxable portion significantly, resulting in lower tax liabilities for their heirs.
How Much Tax Can Be Saved?
The exact tax-saving potential varies depending on the super balance and the timing of withdrawals and recontributions. For example, consider a client, Mick, with a super balance of $1.8 million at age 67, all of which has been taxed at 15% upon contribution. By withdrawing and recontributing $120,000 annually (the current non-concessional contribution cap) for nine years, Mick could make $1.08 million of his super tax-free. In this scenario, his adult son would only be taxed on the remaining taxable component of $720,000, rather than the entire $1.8 million, reducing the tax bill by over $160,000.
Furthermore, if Mick began this strategy earlier, at age 60, he could potentially make his entire super balance of $1.8 million tax-free, leaving his son with a fully tax-free inheritance.
Key Considerations and Risks
While the recontribution strategy presents significant tax-saving potential, it is not suitable for everyone. You should assess their financial circumstances and retirement goals or discuss with Cadre Capital Partners before deciding to implement the strategy. A few important considerations include:
- Super Balance Limits: You must ensure your super balance is below the $1.9 million cap to make non-concessional contributions. If your balance is above this limit, you may not be eligible for the strategy unless you can redistribute your super to your spouse (if applicable).
- Contribution Limits: The non-concessional contribution cap is currently set at $120,000 per year, with the ability to bring forward contributions for up to three years ($360,000) in a single year. If you plan to use the bring-forward rule, you must wait for three years before making additional contributions.
- Spouse Contributions: In cases where one spouse has a higher super balance, but both spouses are involved in the strategy, a redistribution strategy could be effective. This would allow the higher super balance to be split between both spouses, potentially reducing overall taxable components and maximizing the tax-free benefits.
- SMSF Considerations: A self-managed superannuation fund (SMSF) can be particularly beneficial when implementing a recontribution strategy. With an SMSF, the withdrawn and recontributed amounts can be more easily managed and kept separate from the rest of the super balance, offering greater flexibility for tax planning and inheritance structuring.
Is the Strategy Popular?
The popularity of the recontribution strategy has surged following the changes to the work test. Data from SMSF administrators such as Class reveals that 51% of non-concessional contributions in 2022-23 came from those aged 65 and over, with the largest increase seen in those over 70. This group accounted for 26% of non-concessional contributions in 2022-23, compared to just 8% the previous year.
The total value of non-concessional contributions from those aged 70+ rose from $232 million to $936 million in just one year, highlighting the growing adoption of this strategy. As more clients become aware of the potential benefits, it is expected that this trend will continue to grow.
Conclusion
The superannuation recontribution strategy is a powerful tool for those looking to reduce the tax liabilities on superannuation inheritances. By understanding the mechanics of the strategy and the recent changes to superannuation rules, you can create more tax-efficient estates and preserve wealth for future generations.
While the strategy may not be appropriate for everyone, it offers substantial benefits for clients who plan to leave a significant super balance to their beneficiaries and are looking to minimize tax liabilities in the process. As the trend continues to grow, it is crucial for clients to consider how this strategy fits into their broader retirement and estate planning goals.
If you think this strategy may apply to you, please reach out to Cadre Capital Partners to discuss this strategy and how it may be applicable to you and your situation.
