Inheritance tax trap: How super savers get slugged twice

The number of people set for a 17 per cent tax bill when they inherit super is about to increase substantially. But there are steps you can take to reduce your exposure.

There are ways to reduce the tax paid on inherited super balances. Picture: iStock

Australians face a double tax hit when they inherit super savings following recent changes to superannuation rules.

As the size of the nation’s super savings expands dramatically, the amount of tax collected from inherited super is also set to rise.

Many people do not realise it, but inherited super balances mostly arrive with a hefty 17 per cent tax bill.

In theory, Australia does not have an inheritance tax, but the 17 per cent tax applied to inheritance inside the super system amounts to the same thing.

The issue is steadily becoming mainstream as the amount that you must put into super by law increases each year.

This amount, known as the SGC (superannuation guarantee contribution), goes into your super account with a tax concession. When it comes out the other end as inheritance the government demands that the initial concession is refunded.

Anna Hacker of Pitcher Partners said not enough people factor in the tax hit.

“More and more we see super as the biggest asset, yet there is a lack of understanding of how it works when it comes to estate planning,” she said.

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It might have sounded like a good idea at the time compulsory super commenced in 1992.

But back then the SGC was only 3 per cent of your salary package. From July 1 this year it has been set at 12 per cent.

The super amounts that benefited from tax concessions now dominate the amounts held in super accounts.

As a result, the majority of super that will some day become an adult child’s inheritance is classified as taxable.

It’s a neat circle for the Australian Taxation Office, which collects more tax from more people each year.

On top of the general 17 per cent tax bill faced when inheriting super, those trapped by the new super tax, the unindexed new 15 per cent tax on earnings on amounts above $3m, also get a second sting.

That’s because the new tax is based on unrealised gains.

If the original super fund had tax credits linked with the new tax due to past losses, those credits become void for anyone inheriting, but any bills for unrealised gains due under the same tax remain due.

How to minimise the tax hit

With the widening of tax claims on those inheriting super, estate planners and financial advisers are now pointing investors to a little-known investment technique which can cut down the level of tax due on super inheritance.

It’s called a recontribution strategy and it is generally open to anyone running a super account who is between 60 and 75 and wants to minimise the tax their family will pay in the future.

Here’s how the recontribution strategy works.

It may sound absurd but don’t worry, the super system is full of absurdities.

Put simply, it involves taking money out of super and putting it back in.

The super saver aged between 60 and 75 withdraws money from super, which they can do tax-free, and then contributes that same money back into their fund.

This will also be tax-free in that it is classified as a non-concessional contribution, that is, tax is not applied in this situation.

Every time there is a recontribution, the fund gets more money, which is classified as non-taxable. At the same time, crucially, the taxable total drops.

Over a period of time with successive adjustments, the taxable component continually shrinks.

Or to put that another way, with each annual recontribution, there is more money passed through where there is no tax due to be paid.

For most super savers the recontribution strategy may take some time to create a significant reduction in the tax due on a future inheritance.

As always with super there are rules and conditions to consider.

The outstanding limitation is that recontribution amounts count towards what are tagged as non-concessional contribution caps. Currently, the non-concessional contribution cap is $120,000 a year.

As for a workaround on the extra inheritance sting with the new super tax, there is no obvious strategy just yet for dealing with the wasteful cancelling of tax loss credits.

But then again, many investors are already steering money away from super once amounts reach close to $3m as they seek to avoid the new super tax and the controversial issue of taxing unrealised gains.