Re-contribution strategies unlock tax savings for retirees and beneficiaries

Pulling money out of an account and then gradually putting it back in seems like the ultimate exercise in futility.

Yet thousands of people do just that every year in what the superannuation industry calls a “re-contribution strategy” which has become something of a badge of honour among retirees.

In simple terms the strategy – which is shorthanded as “savings tax for the kids” or even a way of avoiding an unofficial death tax – is both more important and much less important now than ever.

The key to the strategy is that all superannuation accounts are automatically split into two categories – concessional contributions and non-concessional contributions.

Concessional contributions include employer contributions, personal contributions on which you have claimed a tax deduction, and investment earnings.

Saving tax for children by re-contribution

If after your death the super fund ends up being paid out to financially independent children, that taxable component of concessional contributions can end up as taxable income – up to 15% tax plus the Medicare levy if it is applicable, and up to even 30% plus Medicare and above in certain circumstances, depending on the tax situation of the independent child.

If a re-contribution strategy is successfully employed then it can turn an entire super account into a non-concessional contribution, which is no longer subject to tax in the hands of non-financially independent children.

This is where things can get tricky and quite technical and creates some varying opinions among financial planners.

Withdrawal before death also a good strategy

Some are quite strongly against even bothering with the sometimes difficult process of re-contribution, saying that strategically timed capital withdrawals by yourself and/or a surviving spouse can achieve the same result much more easily.

Such withdrawals can even be met through instructions to an accountant who can withdraw any remaining superannuation as a client’s death becomes more likely.

Death can be untimely

Of course, death is one of those things that can come without warning through accidental means which is why some of those in the re-contribution camp think it is best to remove the possibility of accidentally triggering tax liabilities for the ensuing generation.

Pursuing a re-contribution strategy can be quite complex and is likely to require professional help which is another consideration, given that there is no possible benefit for the owner of the superannuation account, other than peace of mind delivered from erasing a potential future tax bill for the next generation.

For those who do pursue re-contribution to avoid one of the few occasions in which capital is taxed directly, these are just some of the technical issues that need to be considered and pitfalls that need to be avoided.

Withdraw and deposit easier said than done

To successfully do a re-contribution you need to be able to do two things – withdraw money out of super and put it back in.

That sounds simple but depending on several factors it can get quite complex.

In general, the key to withdrawing from super is to reach the age of 60 and to not be working or reach the age of 65 even if still employed.

That can be tricky but it is nothing like the technicalities of re-contributing back into super.

Limits on non-concessional contributions

There are limits on the amount of non-concessional contributions that can be made every year, with the current limit being $120,000 a year, with a few exceptions.

People who have more than $1.9 million in super at June 30, 2024 can’t make any contributions in 2024-25, while those with much less in super can contribute up to three years’ worth of non-concessional contributions at once – that is, $360,000 in 2024-25.

There are also age restrictions, with non-concessional contributions not being allowed once you turn 75.

So that means there is a timing element, with re-contributions possible between the ages of 65 (and sometimes 60) up to 75, which allows a fair amount of time to complete a gradual re-contribution strategy to allow for limits on contributions.

Obviously, the amount of time it will take to re-contribute will be a factor of how much is in your super and how many years it will take to re-contribute under the bring-forward rules.

Asset allocation complications

This highlights another wrinkle with the re-contribution strategy, with the asset allocation for retirement funds potentially compromised while leaving future contributions liquid enough to access them when the time comes to transfer more super back into the fund.

Another complication is potentially delaying the switch from accrual to pension mode, which can be a significant barrier if you have a large balance and want to start a pension from the entire lump sum.

There are some strategies within self-managed super funds to manage different rolling pensions and to use that method to keep non-concessional contributions isolated within the same fund.

However, if you want to only use non-concessional funds to start a single pension then you might have to wait some time before drawing regular income from your super, although you can obviously make other withdrawals.

Ratios remain important

Yet another complication here is that it is not possible to withdraw just from the taxable components of your super – the taxable and non-taxable components must be withdrawn together in the same ratio they are held in the fund, so the entire super account needs to be progressively re-contributed to remove all taxable components.

None of this is too difficult for smaller balances but the closer they are to the current $1.9 million pension phase limit, the longer a total re-contribution strategy will take.

So, pursuing a re-contribution strategy is not something to be undertaken lightly, although the potential tax savings of about $54,000 for every $360,000 successfully re-contributed is certainly a worthwhile amount for your beneficiaries to save.

However, the alternative of eventually simply withdrawing your super and turning it into normal investments that will be tax free to those inheriting is also a strong contender, particularly as those above 65 don’t face any limits on the amount of super they can withdraw.

The question then becomes one of timing, given that assets held within super remain tax free while those outside super are generally taxable even for those who are retired.

It would be quite an own goal to incur tax bills yourself in the process of trying to save some future tax bills for your children.