A recontribution (or recycling) strategy is the process of withdrawing benefits from a member’s superannuation account and then making a non-concessional contribution (NCC) of the same money back into the fund. The primary objective of this popular strategy is to convert all or part of a member’s taxable component into tax-free component.
In order to undertake a recontribution strategy, the member must have first met a condition of release to withdraw benefits (or already have unrestricted non-preserved benefits), plus be eligible to contribute into superannuation. There are a number of reasons why fund members may wish to undertake a recontribution strategy, including:
- Improving the tax-effectiveness of a superannuation income stream paid up to age 60;
- Reducing the tax impost on death benefits paid to non-dependant beneficiaries;
- Hedging against legislative risk (transferring benefits to a spouse); and
- Improving the tax-effectiveness of a superannuation income stream paid up to age 60
A recontribution strategy can be effective for a member receiving an income stream prior to age 60, as any pension is assessable income to the recipient. Where a member has satisfied a condition or release, they have the ability to withdraw a lump sum and re-contribute this amount to improve the tax-free component of the income stream. From a strategy viewpoint, this taxable component withdrawal is typically taken up to the low rate cap amount ($165,000 for 2011/12), taken in proportion with any tax-free component. Where an income stream is started after the re-contribution, the proportions of the tax-free and taxable components are ‘locked in’ at the commencement date. These proportions are then used to determine all future income payments and commutations that the member receives. Subject to the member’s personal tax position and pension amounts to be taken, the recontribution amount may be more effective to operate as a separate interest. That is, establish two separate pensions, one made up entirely of tax-free component.
Reducing the tax impost on death benefits paid to non-dependant beneficiaries
Since 1 July 2007, benefits received in the form of a lump sum or income stream from age 60 are tax-free in the hands of the recipient. As a result, the primary driver for a recontribution strategy post age 60 is to improve the tax position of death benefits paid to non-dependent beneficiaries, whether directly or via an estate. Where a non-dependant beneficiary (i.e. adult kids) receives a lump sum death benefit, they will be taxed on the taxable component at 16.5%. Therefore, the use of a recontribution strategy can provide a tax saving of up to 16.5 cents in every dollar that is recycled.
For a fund member aged 60 – 64 (having met a condition of release), they could effectively withdraw up to $450,000 of their benefits tax free and recontribute this amount back into the fund, providing an estate planning benefit of up to $74,250. Again, it may be beneficial for the member to run a multiple pension strategy as the recontribution will be made up of entirely tax-free component.
Recontribution to a spouse
Prior to the introduction of Simpler Super (pre 1 July 2007), a recontribution from the member to a spouse account was an effective income-splitting strategy. With the tax-free status of benefits post age 60, this strategy has been diminished. It does however have limited application for members where one spouse may be significantly older than the other, for example where one member is under 60 and one member is over 60 years of age. Consideration of the spouse’s age and eligibility to accept the contribution must be considered as part of any recontribution strategy.
The issue of changing government policy is always at the back of people’s minds when it comes to superannuation. Whilst a withdrawal post 60 as a lump sum or pension is currently tax-free, is it always going to be the case?
A recontribution to a spouse can be used to ‘hedge’ against future legislative risk.
Practically how it must work
To undertake a recontribution strategy, this money must be physically withdrawn from the fund, paid to the member and then deposited back into the fund as a contribution. An accounting entry is not sufficient; there must be a debit and corresponding credit within the fund’s bank account. A recontribution strategy can be undertaken when the member is either in accumulation or pension phase. The tax treatment of any benefits taken need to be considered when determining whether the withdrawal as a lump sum or pension (i.e. under age 60). Where there is insufficient cashflow to undertake a recontribution, this strategy could be undertaken as an in-specie lump sum (not as in-specie pension payments). Any recontribution of assets is subject to the exceptions outlined in section 66 of the SIS Act. Where the lump sum or pension withdrawal is taken by a member under age 60, the appropriate statutory reporting to the Australian Taxation Office will apply, including reporting of benefits on the Fund’s Activity Statement, preparation of PAYG payment summaries, etc.
Tax Office’s view on recontribution strategies
The ATO’s view of recontribution strategies dates back to August 2004, where they issued a media release that stated various straightforward recontribution strategies would not attract the general anti-avoidance provisions (Part IVA) of tax law. Since the introduction of Simpler Super on 1 July 2007, the ATO’s position on recontribution strategies has been addressed through an industry stakeholder Q&A document, that outlines that where a “…recontribution strategy that is carried out to minimise the tax that might be payable on a death benefit paid to a non-dependant, the Commissioner is very unlikely to apply Part IVA to such an arrangement”. It is important to note that this view is not legal binding on the ATO and that they would assess each scenario on a case-by-case basis.
Recontribution vs. Anti-detriment payment
An alternative to undertaking a recontribution strategy, is to consider whether the beneficiaries would otherwise be eligible to receive an anti-detriment payment (refund of tax paid on contributions). This is important because a spouse or child or any age (including non-dependent kids) are generally eligible for an anti-detriment payment when a death benefit is paid as a lump sum. However, as the anti-detriment payment is only paid on the taxable component, using a recontribution strategy to recycle taxable component to tax-free component will reduce or eliminate any anti-detriment entitlement of a deceased member. The anti-detriment tax deduction can assist in the reduction of capital gains within the fund when benefits ultimately need to be paid out to non-dependant beneficiaries. It can also be an effective inter-generational tool for children to take over your SMSF with significant tax benefits.