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Self Managed Super Fund (SMSF) Article
Withdraw and Re-Contribution Strategy

By Tony Negline.

This article may be out of date.

23rd April 2008

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Last week the Government gave super investors some very good news.  Senator Sherry, Minister for Superannuation and Corporate Law announced that Costello's Better Super policies would not be touched by the new Government.

“Labor provided bipartisan support for Better Super and we committed to keeping it at the election, including preserving the current tax treatment of super benefits,” Minister Sherry said in his Press Release.

In the past we never knew what the super rules would be from one moment to the next because they always seemed to be changing.  At least Senator Sherry has given us comfort that we can look carefully at some strategies knowing that they might not change for awhile.

A well known and common superannuation tactic for retirees over the last ten years has been the "withdraw and re-contribution strategy" which seeks to increase the tax efficiency of retirement incomes.

The strategy involves taking a lump sum out of the super system and then contributing that money into the same, or another, super fund.  In nearly all cases the strategy's transactions are conducted either just before, or just after, retirement.

One purpose investors aged under 60 might want to use "withdraw and re-contribute" will be to get more tax-free money out of their pension.

In order to understand how this occurs some important background information is essential.  Every super fund member's benefit is split between tax-free and taxable components.  The bigger the tax-free portion, the less income tax that may be paid.  These components are worked out on 30 June 2007 for people who were members of a super fund on that date.

For example, Betty Smith is aged 58 and just retired.  She has $2.5m in super benefits.  We'll assume that before doing the 'withdraw and re-contribution strategy', $1.15m (or 46%) is noted as Tax-free Component; the balance (54%) is Taxable Component.

She withdraws $255,000 from her super benefits as a lump sum.  Forty six percent of this ($117,300) will be tax-free; the balance ($137,700) will be taxable.  Her Tax-free Component will be reduced to $1.03m ($1.15m - $117,300) because of this withdrawal.

Under the old super rules Betty might have been able to withdraw only the Taxable Component.  The new super rules do not allow this.  As Betty is aged between 55 and 60 she is able to access her lifetime tax-free limit for the taxable component of $140,000.  Therefore this whole $255,000 is tax-free.  In this scenario we are assuming that she has not taken any other lump sum withdrawals from super between age 55 and the time of this particular withdrawal.

She now takes this lump sum and contributes it back into her super fund as an undeducted contribution.  Her tax-free benefit now increases to $1.28m or 52% of her total benefit.

If Betty started a pension fifty two percent of any pension or lump sum withdrawals will always be tax-free.

If she uses all her super money to start a pension then the minimum pension she must pay herself is 4% of the account balance ($100,000).  The Taxable Component portion of pensions paid to people aged between 55 and under 60 are subject to normal income tax rates less a 15% rebate.  The smaller the proportion of a benefit that is Taxable Component the smaller the income tax bill will be.

Assuming Betty has no other income and she did not withdrawal and re-contribute she would have to pay $2,700 income tax.  With the "withdraw and re-contribute strategy" her income tax bill is reduced to $900 – a saving of $1,800 each year.

As the saying goes, "we're not talking sheep stations".  Over the next three financial years this saving gets smaller as the government's future tax cuts take effect.

So why would Betty bother?

Well she may want to do the "withdraw and re-contribute" transactions because she is looking to make life a little easier for her children.  When Betty dies any Taxable Component of her super benefits paid to non-dependants has to be paid as a lump sum and will be taxed at 16.5%.

Let's move forward 25 years and now assume that Betty is 83.  If her fund averages a 7% return net of all costs and other costs and her income payments are indexed by 4% each year then her pension account balance will have grown to over $3.5m.

Without the "withdraw and re-contribution strategy" fifty-four percent of this amount - $1.89m is taxable component.  If this is paid to her non-dependant children over $311,000 tax will be paid.

With the "withdraw and re-contribution strategy" her taxable component reduces to $1.68m and the tax paid by her non-dependants reduces to just over $277,200.  This represents a saving of $33,800.

What about people who are aged at least 60 but under 65?  These people are in a very different position as they may be able to withdraw up to $450,000 tax-free in one year and re-contribute it back into super which would increase the overall tax savings.

What about investors who are at least age 65 but under 75?  The total undeducted contributions that these people can make is $150,000 in a financial year and before making the contribution they must have satisfied a work test.

Here we have discussed the impacts of doing this strategy.  There are many steps that have to be considered before implementing it which we will address at another time.

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