The proposed reduction in the non-concessional contributions cap from 1 July 2017 in the amended budget package provides a number of opportunities when considering re-contributions strategies in this financial year.
The amended proposal reduces the annual non-concessional contributions cap from $180,000 to $100,000 for anyone with a superannuation balance of no more than $1.6 million. The three-year bring-forward rule has been retained for anyone under 65.
Re-contribution strategies have been used for well over a decade for anyone who has access to a non-preserved component in their superannuation fund. The strategies provide a useful way of converting a taxable component to a non-taxable component by making a non-concessional contribution to the fund within the cap limits. However, the re-contributions strategy does have its limitations as the potential tax saved can end up being more expensive than putting it in place. This would apply especially where the taxable component of the benefit is relatively small.
For anyone between their preservation age, currently from 56 to 60 years, any amounts withdrawn from super that include a taxable component can be recontributed as non-concessional contributions up to the relevant cap. This usually results in a higher tax free component if a lump sum or income stream benefit is drawn down prior to reaching age 60. For a client who is 60 or older the re-contributions strategy can be useful as an estate planning tool. The estate planning benefit arises if a death benefit is paid to a non-dependant for taxation purposes, generally a child of the member who is over 18.
The opportunity that arises in this financial year if the announced changes to non-concessional contributions start from 1 July 2017 is that the higher non-concessional contributions cap can be used. Depending on the client’s age the annual cap is currently $180,000 with a three-year bring-forward amount of $540,000 for anyone under 65.
The question is how much should be withdrawn from superannuation to maximise the use of the re-contribution strategy? The answer depends on the age of the client wishing to do the re-contribution strategy, the size of the taxable component and how much of the non-concessional cap is available to make the re-contribution.
Let’s consider the situation for anyone who is under 65 and wishes to withdraw an amount from super and has not triggered the three-year bring-forward cap since 1 July 2014. As the bring-forward rule has not been activated it will allow them to maximise the re-contribution strategy for this financial year. The amount withdrawn can depend on the amount of tax they may need to pay as well as the client’s age. As indicated above, tax may be payable where the client withdraws the benefit prior to reaching age 60. If the person is between preservation age and 60 up to $195,000 of the taxable component is exempt from tax.
The chart indicates the maximum amount that should be withdrawn to maximise the non-concessional contributions cap based on the taxable component of the amount withdrawn. For anyone 60 or older, as no tax is payable, the amount withdrawn would be $540,000 as no tax is payable on the amount withdrawn and re-contributed.
If the amount required is to be withdrawn between preservation age and age 60 tax becomes payable once the taxable component is greater than 36.11 per cent of the $540,000 that will be re-contributed. This is due to the first $195,000 of the taxable component being tax exempt and assumes none of that threshold has been used previously. Therefore, if tax is payable on the amount withdrawn from the fund the gross amount withdrawn needs to take into account any tax payable. For example, if the taxable proportion of the amount to be withdrawn between preservation age and age 60 was 80 per cent of the total amount then the lump sum to be withdrawn would be $588,542.
One discussion that has often arisen at the same time as the re-contribution strategy is whether it is better to use than payment of an anti-detriment amount from the fund. The proposals in this year’s budget propose to do away with anti-detriment payments from 1 July 2017. An anti-detriment payment can be made on a member’s death where a lump sum has been made to the surviving spouse or children of the member. It is to compensate for the amount of tax paid on taxable contributions made in respect of the deceased. In some situations, the anti-detriment payment can produce a better net result after tax, however, the member needs to be deceased before the payment is made. A decision on whether the re-contribution strategy or anti-detriment payment should be used in this financial year depends solely on individual circumstances.
Consideration of the re-contribution strategy is something that should be made sooner rather than later for clients. While the budget proposals are yet to make it through the parliament and become law, it could take a little while to get everything lined up, especially if an SMSF is involved or the person’s superannuation balance is nearing $1.6 million. Payment of the required amount will not only involve calculating how much is required but also determining which assets in the fund may need to be transferred or sold so enable the payment to take place.