Keeping intergenerational super fund payments tax-efficient
‘Nothing is certain in life, except death and taxes’. the task is to ensure that death doesn’t mean tax.
Last year the government released regulations confirming the continuing tax-free status of a superannuation fund in pension phase following the member’s death.
However, there is a second layer of tax that applies to superannuation death benefits received by non-tax dependent beneficiaries (such as independent adult children).
If you are at least age 60 all superannuation withdrawals made by you are tax-free and if you die, your benefits can be paid to a tax dependent, such as your spouse, tax-free.
Taxable and tax-free
However, superannuation benefits generally consist of taxable and tax-free components  that have different tax implications when received by an independent adult child not classified as a tax dependent .
Tax-free components include non-concessional (after-tax) contributions and the taxable components make up the remainder (i.e. earnings while in accumulation phase and concessional contributions).
Independent adult children pay tax of 15% (plus Medicare) on taxable superannuation death benefits, while tax-free components are received tax-free.
Minimise the tax
In order to potentially reduce tax on a future superannuation inheritance it may be possible to undertake a re-contribution strategy.
This involves withdrawing a taxable lump sum from superannuation and re-contributing the amount as a non-concessional contribution, thereby replacing taxable components with tax-free components.
In order to undertake the strategy the member must be able to:
• access a tax-free lump sum payment from their superannuation fund (which usually means that they are at least age 60 and retired); and
• make a superannuation contribution (be less than age 65 or still working).
The withdrawal must actually be paid out to the member (it cannot be just a book entry) and the strategy usually works best when the member has already commenced a superannuation pension, so that any assets sold down to make the payment are not subject to tax in the superannuation fund.
Use of bring-forward rules
All contributions must be made within a member’s annual non-concessional (after tax) limit.
Note that new and higher contribution limits apply from 1 July 2014 (see right).
It also often makes sense to utilise the bring-forward rules (which, subject to circumstances, may allow the following two years’ limits to be used in the current year).
Example of benefits
Mark is age 61 and retired last year (and has not made a non- concessional superannuation contribution for the past three years).
He has $2.5 million worth of assets in a sole member self managed superannuation fund and has commenced a superannuation pension, which is comprised of 80% taxable and 20% tax-free components.
If he died with that super fund balance, his daughter Charlotte, who is age 28 and financially independent, would pay tax of $330,000 on receipt of the superannuation death benefits.
To better manage the situation, Mark draws down on an overdraft against his home and makes a $150,000 non-concessional superannuation contribution in June 2014 and a further $540,000 contribution in July 2014.
$690,000 is subsequently withdrawn from his existing superannuation pension to repay the loans.
Mark then commences a second (100% tax-free) superannuation pension with the recent contributions.
In the event of Mark’s (immediate) death, Charlotte would now pay $238,920 on receipt of his superannuation benefits (i.e. representing a tax saving of $91,080).
Mark intends to undertake this strategy again when he is 64 and can once again make non-concessional superannuation contributions within his limit.
This would further minimise the tax that Charlotte would pay.
Too often investors ignore, or forget, the consequences of their demise.
If you are below age 65 or still working and less than age 75 you may wish to consider a re-contribution strategy.
It is important to remember that each person’s circumstances are unique. And thus each strategy must be designed to suit each individual.
Annual concessional (pre-tax & tax deductible) limit
$35,000 for those age 59 and over on 30 June 2013; and $25,000 for everyone else.
$35,000 for those age 49 and over on 30 June 2014; and $30,000 for everyone else.
Annual non-concessional (after-tax) limit
Up to $450,000 using the following 2 years’ limits in advance (only available for those under age 65).
Up to $540,000 using the following 2 years’ limits in advance (only available for those under age 65).