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Re-contributions another victim of Budget

Re-contribution strategies are widely-used to minimise the impact of the so-called ‘death tax’ on death benefit lump sums paid to adult children of deceased superannuation members. Unfortunately, it could be a casualty of the proposed new rules for non-concessional contributions contained in the Federal Budget.

Whether or not the Government intended to deliberately affect those who implemented this strategy by restricting their future access to non-concessional contributions, this would be the result if those proposed changes became law.

The proposal to limit the non-concessional contribution cap to a lifetime $500,000 can be seen for what it is – a need to shut down people contributing millions of after-tax dollars into the tax-effective superannuation environment.

So what is the context of this re-contribution strategy, how has it been used in the past and how do the proposed changes impact those who have adopted it?

The core purpose of superannuation

A core purpose of superannuation is to provide benefits to members in their retirement. These benefits when received are either not taxed at all if the recipient is 60 or over, or very concessionally taxed if under 60.

Notwithstanding this core purpose and while they are alive, members can also choose not to take any sort of benefit from their super arrangement and leave their account balance in accumulation phase indefinitely.

Payments on death of a member

Another core purpose is the payment of benefits on the death of a member to their legal personal representative or dependants. Unlike when a member is alive, however, regulations require the death benefit be paid as soon as possible after death.

The taxation of the benefit, which must be paid in these circumstances, will depend on who the death benefit is paid to, and the type of death benefit allowable depends on who the recipient is:

a)  Payments to death benefit dependants

Lump-sum death benefits paid to a surviving spouse, child under 18, someone in an interdependent relationship or financially dependent on the deceased, are tax-free. Death benefit pensions are also payable to these dependants and are either tax free or concessionally taxed.

b) Death benefits paid to other dependants such as adult children

For adult children of the deceased, the options are more limited in terms of benefits payable and the taxation of those benefits. Only death benefit lump sums can be paid to these individuals under superannuation and tax rules. Pensions cannot be paid to adult children of the deceased member, except in limited circumstances and only for limited periods of time.

This is mainly to prevent successive generations passing on entitlements to pensions to the next generation, regardless of their age or retirement status. In this scenario, if allowed, adult children of the deceased would receive a tax effective or even tax-free pension prior to their normal retirement age, and the underlying investment income derived from the assets supporting the pension would be tax free within their fund.

The legislative response

By only allowing adult children to receive a lump sum death benefit, the deceased member’s account balance is forced out of the superannuation system, short-circuiting the pension in perpetuity strategy. The only way for this money to find its way back into the super system is by way of a contribution by the adult children. These contributions are limited by caps and access to account balances is also limited until a later condition of release has been met. There are, however, consequences in limiting the benefits payable to adult children.

The death tax

Death benefit lump sums paid to adult children are subject to a flat tax rate of 15% plus the Medicare levy on the taxable component of the lump sum. All attempts to lobby successive governments to change this tax treatment, often dubbed the ‘hidden superannuation death tax’, have failed, to the point that it is not generally accepted as an item for discussion at all.

So if politicians and bureaucrats won’t talk about it, how can advisers, whether they are accountants, financial planners, lawyers or administrators, help to mitigate the impact of this tax?

Strategy from advisers to increase the tax-free component

The most common response to date has been to reduce the taxable component of the death benefit lump sum (the amount subject to tax at 15% plus the Medicare levy).

For many years, both before and after the change in the calculation of the components of superannuation entitlements from 1 July 2007, common strategies have included:

a) re-contribution, which involves cashing out superannuation entitlements from unrestricted non-preserved components, paying any tax applicable, if at all, then using these proceeds to make a non-concessional contribution back into the super arrangement, or

b) simply making large non-concessional contributions from sources outside superannuation into the member’s super account.

Both strategies have successfully increased the tax-free component of the contributing member’s account balance and reduced the taxable part. Hence, the impact of the tax on death benefit lump sums paid to adult children has been minimised. The strategies were accepted by the ATO as legitimate for tax planning.

This was done in good faith by members of all types of super arrangements in an environment where non-concessional contribution caps were initially set at $150,000 per year with the ability to contribute up to three years’ worth ($450,000) at any time in a three-year period. More recently, this was increased to $180,000 per year or $540,000 in a three-year period.

The new problem

The consequences of the Government’s decision to count non-concessional contributions made as part of the re-contribution strategy described in example (a) above from 1 July 2007 against the new lifetime cap, appears to have not been considered.

These non-concessional contributions have not been funded from large non-superannuation resources, but from existing saved super entitlements, which have been recycled to improve the tax consequences of certain death benefits. They have not substantially increased the account balances of the members who have undertaken these strategies. In fact, the account balances in some instances have been reduced by the lump sum tax paid on the benefits withdrawn before being re-contributed.

Unintended or not?

It is not possible to know whether this was an intended consequence of the Budget announcements or not. Discussions have centred around large non-concessional contributions made prior to Budget night that have substantially increased member account balances.

If nothing else, it highlights the complexity of amending superannuation legislation in Australia, where a change in policy and subsequent amendment of relevant legislation can have a wider-than-expected impact on the actions of people acting appropriately and legally when saving for their retirement.

It also draws into question the ongoing use of the re-contribution strategy as a means of minimising the impact of the tax on death benefit lumps sums paid to adult children of deceased members. It may even provide an unexpected windfall in tax collected on death benefit payments made in these circumstances.

 

Peter Hogan is Head of Technical, SMSF Association. This article is general information and does not consider the specific needs of any individual.

 

10 Comments
Daryl
August 21, 2016

Cambo, not going to happen mate. The knowledge base of some financial journos is poor. That is why we subscribe to Cuffelinks or read Trish Power's newsletters and the like.

Just wait until we get the dog's breakfast of new rules/exemptions of the retrospective cap issue.

Its too simple so it wont happen, but for mine don't have lifetime contribution caps, don't have limits of $1.6m etc

KISS principle.

15% tax on earnings in pension phase like the accumulation phase AFR reports Treasury figures suggest it will raise $4b pa

Or if you must to get it through the party room 10%

As i said its too simple and wont happen.

Harold Cochrane
August 19, 2016

Rather than introduce more complex rules, why not just reverse the tax concessions set by Peter Costello in 2006. We would not be any worse off than we were prior to 2006 (or would we?)

Adam P
August 19, 2016

I have written to the Minister for the FSC & Financial Institutions = Kelly O'Dwyer about re-contribution strategies and this crazy retrospective proposed legislation.
In her response, she had the hide to regurgitate the basics of the super changes from the budget to me, plus some basic policy rhetoric and then, the government are still sticking their head in the sand to try to say this is not retrospective legislation.
O'Dwyer flat out denies that it is retrospective ???

Sonja
August 19, 2016

Of course this was intended. Public servants are not stupid. Re-contributions to minimise tax were the subject of a (reluctant) ATO ruling, which deemed that they were legal. Doesn't mean they approve of them and won't try and stop them. Best way, as Chris writes, is to drain the account before a member dies, but that assumes you know when that is likely to be.

Jacques Calluaud
August 19, 2016

You make the comment "The proposal to limit the non-concessional contribution cap to a lifetime $500,000 can be seen for what it is – a need to shut down people contributing millions of after-tax dollars into the tax-effective superannuation environment." Surely this is done by the $1.6m limit on tax free superannuation balance. There should be no limit on contributions as the government should be encouraging everyone to get to $1.6m so that they can retire without being a burden on the public purse. Due to costs during life, mortgage, school fees and non working time due to children most need the ability to top up their super and the govt for unclear reasons has decided to limit this to $500k.

Chris Jankowski
August 18, 2016

It should be remembered that instead of the complex paper shuffling the easiest way to avoid the tax is to drain the account of a member before they die. The member then can gift the money to whomever they want to.

Philip
August 18, 2016

Tax on lump sums paid to the adult children on the death of the super member is at 15% - which is simply collecting (some of) the concessions allowed the dead taxpayer along the way. It is entirely fair, just as it is that the re-contributions dodge is eventually curbed (not removed, just limited). Superannuation was never meant to be an estate planning tool and we should ensure that taxes previously conceded for members are collected before benefits are paid to those other than the financial dependents of the deceased members. This country has a culture of tax avoidance and as a result, a revenue problem, because far too many think everyone should pay but them. Grow up and get over it. If you prefer to live in a tax haven feel free to relocate. You'll not be missed.

Cambo
August 19, 2016

Actually the total amount taken by the Govt upon the death of the super member is 17% (15% plus Medicare levy of 2%).
However what irks me in this whole debate are the numerous incorrect statements by Treasurer Morrison that he does "not want parents using super to set up a tax-free inheritance for their kids."
When money goes into super via the SGC of 9.5%, it is taxed at 15%. Earnings and capital gains in the accumulation phase are also taxed, albeit concessionally.
Any non-concessional contributions comprise funds that have already been taxed (ie salary, dividends, interest), sometimes at the maximum PAYG rate of 47%.
And when the parent dies, the children's payment from the pension or super fund is further taxed at 17% (15% plus 2% Medicare levy).
Yet not one member of the media has ever challenged Treasurer Morrison on this.
I await the day when a journalist asks:
"Treasurer, all money that goes into super is taxed; the earnings and capital gains are taxed in the accumulation phase, and the inheritance lump sum is taxed again when paid to the kids after the parent dies. So how can you claim parents are setting up a tax-free inheritance for their kids?"

allan
August 18, 2016

Always a guessing game as to whether the Public Service intended matters to have the effect they have after all the majority are in an unfunded pension scheme. That said a more canny PS may have seen a way to increase tax revenue by killing the recont strategy. Either way it will hav ethe effect of making more people suspicious of super due to constant change including now Retrospectivity!

Ashley
August 18, 2016

Surely wait for the legislation – if and when anything comes of it – instead of this chatter about potential possible policy changes and artificial paper-shuffling for the sole or main purpose of reducing tax or maximising welfare.

 

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