As grateful as your kids would be to receive the balance of your super fund as an inheritance, most clients I speak to would prefer to help them along the way if that created a more significant long-term impact.
While the rules can be overly complex, superannuation is often overlooked as a really effective vehicle to help transfer wealth to the next generation. So how can we manage this super death tax while helping the kids along the way? Here are three simple strategies that may help.
A “Recontribution” strategy
Your super fund is generally made up of two components; money contributed to your fund that has already been taxed (tax-free) and money contributed by your employer or that you personally claimed a tax deduction for (taxable). Future earnings also count towards your taxable component.
The tax-free component is ultimately received tax-free by all beneficiaries. However, the taxable component carries a potential tax cost on your death. If passed to a dependent via a lump sum, this is usually tax-free. However, when passing to a non-dependent like an adult child, an extra 15% tax is incurred.
Once you’ve reached your preservation age and retired or turned 65, you are eligible to draw money out of super as a lump sum or through a pension and then contribute it back to your super fund, providing contribution rules are followed. Assuming you’re older than 60, there is no tax to pay on taking money out or putting it back in (“recontributing”). If your super fund has a high proportion of taxable components, you effectively reduce the future tax your kids will eventually pay.
Current legislation allows individuals to contribute up to $110,000 each financial year as after-tax or non-concessional contributions or up to $330,000 in one year using the bring-forward arrangement.
If you have a super fund made up of solely a taxable component, withdrawing and contributing back $300,000 might save your children up to $45,000 in tax ^1.
The recent federal budget has also been kind to retirees by proposing to defer the work test requirement from the 1st of July 2022, meaning you may be able to continue this strategy up to age 75.
Contribution limits apply based on your age, total super balance and transfer balance cap, so seek advice before employing this strategy.
Tax deductions and compound earnings
Although the ability to make personal, tax-deductible contributions to super stops for you once you are aged 67 and finished work, you can help your kids fund their own tax-deductible contribution to super.
For example, helping the kids make a $10,000 tax-deductible contribution each year for 10 years turns a $100,000 head start into just over $167,000 of value, made up of the initial net contribution, super fund earnings and personal tax refunds. After another 10 years of earnings only, their super balance increases by a further $140,000^2.
For some, there is currently the opportunity to play catch up by using the last two previous financial years of contribution cap limits that weren’t met by employer contributions.
The benefit increases as your children’s salary increases, and equally, the benefits reduce when the child’s income drops below $45,000.
Once again, there are many variables to consider, so worth speaking to your adviser before proceeding.
Read more about finance tips for young adults.
A super boost from the government
An annual government co-contribution might provide a nice, early boost to their super fund for children who are just starting their working life.
On a $40,000 total income, a $1,000 personal contribution will result in a co-contribution of $500. A 50% return, day one! The benefit scales down on incomes above $40,000 and cuts out completely at around $54,000. Be aware that your child must have earned at least 10% of their taxable income through employment.
Summing it all up:
Despite complex rules and jargon, it really does pay to take time to understand superannuation and what your options are. For peace of mind, speak to your accountant or financial adviser before proceeding with an option that is best suited for you.
1 $300,000 x 15% = $45,000
2 Assumes 15% contributions tax, 8% after tax return and 32% marginal tax rate.