You work hard to maximise your superannuation while you’re working, so that it can pay you a tax-free income once you retire.
But have you thought about what happens when you pass away and your superannuation gets distributed?
Understanding Taxable vs. Tax-Free Components in Superannuation
Superannuation is one of the best tax-structures to fund your retirement, with currently no tax on capital gains or income once you transfer your accumulation account to an account-based pension.
You may wonder then, why is my superannuation split between taxable and tax-free? Well first let us break down the difference.
Taxable Component: Comprises pre-tax contributions such as employer contributions, salary sacrifice amounts and personal deductible contributions, along with earnings on these contributions
Tax-Free Component: Includes after-tax contributions, like non-concessional contributions made from your take-home pay. It is funds you have already personally paid tax on.
Upon death, if your super is left to a non-tax dependant (e.g., an adult child above the age of 18), the taxable component may incur a tax of up to 17% (15% plus 2% Medicare levy). In contrast, the tax-free component is generally received tax-free by all beneficiaries.
How you can mitigate this?
Luckily there is ways to reduce the impact of this for your children. This is through a withdrawal re-contribution strategy to convert as much of your taxable component to tax-free.
This strategy involves:
- Withdrawing a lump sum from your superannuation (when you are able to access).
- Re-contributing the same amount back into your super as a non-concessional (after-tax) contribution.
Eligibility Criteria
Meet a Condition of Release: Typically, this means you’ve reached your preservation age and have retired.
Be Eligible to Contribute: Generally, individuals under 75 can make non-concessional contributions, subject to contribution caps.
It’s essential to ensure that the withdrawal and re-contribution comply with superannuation rules and contribution limits.
Practical Example
Consider Jenny, aged 65, with a super balance of $600,000, consisting of $450,000 taxable and $150,000 tax-free components.
- Step 1: Jenny withdraws $300,000 from her super. Given her age, this withdrawal is tax-free.
- Step 2: She re-contributes the $300,000 as a non-concessional contribution back.
The $300,000 withdrawn is proportioned to the existing taxable and tax-free split. As Jenny has 75% taxable and 25% tax-free, it means $225,000 of her taxable balance and $75,000 of her tax-free balance is moved out.
Before contributing back, her $600,000 balance is now $300,000 with $225,000 taxable and $75,000 tax-free.
When she contributes back it will add $300,000 all tax-free. This will now mean she will have $225,000 taxable and $375,000 tax-free meaning her previously 75% taxable is now 37.50% taxable.
In $ terms, at 17% tax this would save $38,250 in tax paid by her children on receipt of her inheritance.
Important Considerations
Contribution Caps: Be mindful of the non-concessional contribution cap, which is $120,000 per annum or up to $360,000 under the bring-forward as of the 2024/25 Financial Year.
Total Super Balance: If your total super balance exceeds certain thresholds, you may be restricted from making further non-concessional contributions.
Timing: Implementing this strategy well before any anticipated health decline ensures compliance and effectiveness.
Professional Advice: Consult with a financial advisor to tailor the strategy to your specific circumstances and ensure adherence to all regulatory requirements.
Final Thoughts
A withdrawal and re-contribution strategy can be a powerful tool in estate planning, helping to maximize the inheritance left to your loved ones by minimizing potential tax liabilities. By understanding the components of your super and strategically managing them, you can ensure a more tax-efficient transfer of wealth.
For personalised advice and to explore how this strategy fits into your overall retirement and estate planning, Schedule your strategy session now and join the Delta family, where we’re committed to navigating this journey with you, every step of the way.
