How to reduce the tax on your children’s inheritance

A withdrawal and recontribution strategy can be an effective way to reduce tax for your beneficiaries when they inherit your superannuation later on.

However, before we can look at how this strategy works, we need to gain an understanding of the tax components that make up your super account balance.

Generally speaking, your super account balance will be made up of two tax components; the taxable component and the non-taxable component.

Contributions made to your super fund on a pre-tax basis form the taxable component of your account balance and contributions made on a post-tax basis form the non-taxable component.

Pre-tax contributions are officially known as concessional contributions and include your employer contributions (e.g. 9%) and any salary sacrifice contributions you elect to make. If you are self-employed, concessional contributions also include any contributions for which you claim a tax deduction.

Conversely, contributions made to your super fund on a post-tax basis are known as non-concessional contributions and include all contributions made by you in after tax dollars (i.e. money on which you have already paid income tax).

The purpose of a withdrawal and recontribution strategy is to convert as much of your super account balance from taxable to non-taxable component as possible.

So what does this mean?

Consider the following example.

Tom is age 62, retired and has $450,000 in his super fund. Of his total balance, 80% is taxable component and 20% is non-taxable component. Upon death, Tom wants his 3 adult children to receive his superannuation benefits in equal shares.

If Tom doesn’t implement a withdrawal and recontribution strategy, his adult children may have to pay tax of up to 16.5% upon inheritance of the taxable component (i.e. $360,000 x 16.5% = $59,400 tax payable). However, the non-taxable component will be inherited tax free by his children (i.e. $90,000 x 0% = $0 tax payable).

Now, let’s assume Tom performs a withdrawal and recontribution strategy. Under the current rules, Tom is able to withdraw his entire super balance of $450,000 and then recontribute it back to the fund. The recontribution is treated as a non-concessional contribution which means Tom’s $450,000 account balance is now classified as non-taxable component. By undertaking this strategy, Tom has converted his entire balance to non-taxable component and saved his children $59,400 in tax.

A withdrawal and recontribution strategy can be undertaken regardless of the type of super fund you have (e.g. self-managed super fund SMSF, industry fund or retail fund).

However, you need to tread carefully if considering this strategy. While it may seem simple in theory, there are a number of traps with the potential to produce dire consequences. Get it wrong and you may end up having to pay penalty tax or find that you are ineligible to recontribute funds withdrawn. This strategy is certainly not for everyone so we therefore recommend obtaining professional advice first.

 


This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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    Financial Planning Expert is an independent financial planning business based in Melbourne. We provide genuinely independent and conflict free financial advice. We’re experts in self-managed superannuation fund (SMSFs) advice and strategy, retirement planning, property and share investment advice, life and income protection insurance, tax planning, asset protection, estate planning and advice for Australian expatriates.