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Self Managed Super Fund (SMSF) Article
Timing of withdraw and re-contribution strategies
By Tony Negline.
This article may be out of date.
7th December 2005
A regular reader has asked the following question: “I understand the withdraw and contribution strategy had to be done before commencing an allocated pension. With the new rules allowing you to start a pension before fully retiring is it possible to start an allocated pension then re contribute the $129,000 after commencement?”
This is an excellent question because there are many issues which need to be addressed and explained.
First of all just a quick re-cap on some background information:
- The withdraw and contribution strategy - The idea behind this strategy is to withdraw a lump sum out of super, pay the required tax and then contribute the net proceeds into super as a new contribution. The purpose of the strategy is to use the current super and tax rules to improve the tax effectiveness of post-retirement income. This strategy doesn't improve after tax experiences for all retirees so before implementing it expert assistance should be sought, if only to confirm that you have correctly worked out how the system works
- The $129,000 refers to the Post June 1983 Tax Free Threshold which is indexed every 1st July. Each taxpayer throughout is allowed to withdraw this amount tax-free during their life. (Until a few years ago the Australian Taxation Office's administration systems did not track if a taxpayer had already received the tax-free threshold and some people exploited this. More recently the ATO have improved their systems and are in the process of recovering any unpaid tax.) Depending on when you started work any withdrawals from super might also contain a Pre-July 1983 Component. Five percent of this component is taxed at your marginal rates.
Now lets turn our attention to answering the question itself. Once a pension has commenced, further capital (that is, an additional lump sum) cannot be added to it.
One the surface this seems like a weird requirement. After all why would it matter if any further capital is added?
This requirement goes back to very old (mainly English) court cases which defined what a pension is. At a technical level once a pension starts the capital is gone and ceases to exist.
Because of this structural attribute, a super fund trustee only has to report pension benefits for Reasonable Benefit Limit purposes when the pension commences or the amount of notional capital is altered via partial or full withdrawal of that capital.
In return for investing capital the pensioner will receive income payments for a period of time. To make the pension payments a super fund's trustees will invest the capital and may or may not earn a capital return for their investing efforts. Another important rule is that pension payments must be made at least once every year.
Technically an allocated pension does not meet all the basic structures that a pension must have however in 1992 the government decided that it would introduce specific laws that made allocated pensions a legitimate pension structure.
Therefore once an allocated has commenced it is not possible to add capital to it.
So how does an investor solve the puzzle of receiving an allocated pension before retiring fully and also making use of the 'withdraw and contribution strategy'?
To gain access to super assets as a lump sum a person must either be aged at least 65 or must satisfy the relevant retirement definition. We will not look too deeply into this definition now but it is important to note that access to super is not allowed if you are over fifty five and are still working more than 10 hours each week. (People who stop work after turning 60 years of age often find it easier to get access to their super.) Clearly access to super before turning 65 can be problematic at best. This means that if you are still working you probably won't be allowed to take money out and put it back in as a contribution.
It is also important to know when super contributions can or can't be made. Contributions can be made a any time if you are under sixty-five. However super investors over age 65 need to make sure they can show they have worked for at least 40 hours in less than 31 consecutive days.
If you have done some modelling and worked out that a pre-retirement allocated pension makes sense (especially from an RBL perspective) and you would also like to take money out of super as a lump sum and contribute it into super then the best way to proceed may be the following: begin the allocated pension with some – but not all - of your super money; then when you finally retire take the balance of your super monies as a lump sum and put it back in as an undeducted contribution and then start another pension.
Alternatively you might like to stop the first pension and combine its capital with the second one. However depending upon your circumstances this can create RBL problems because the RBL system adjusts the value of original pension and also assesses the new pension.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.