I like to say that Maths rules the world. The only problem is that it doesn’t. In the end, what humans feel about an issue dominates. I have noticed the change over the months as we have researched different strategies and sought enhancements and innovation. The language changed from “maximisation” to “optimisation”. With the example below, I think I am going to have to further soften to a “considered decision”.
The ability after age 60 to withdraw a lump sum benefit and recontribute it subject to non-concessional contribution caps provides a mechanism to increase the tax free component. While after age 60 this is irrelevant to the retiree account owner, it is useful from an estate planning perspective in that the payment to a non-financial dependent (let’s say an adult child) will then have a lower tax impost. I am ignoring here other reasons as to why a recontribution strategy may be used. The problem is that the anti-detriment based on the formula approach is also reduced.
A small side track. I notice most examples use a current death. The anti-detriment formula has duration aspects and so tends to increase with the passage of time. So I think the evaluation would be better taking the anticipated date of death into account. In the case I worked on this week, the account was owned by the female member of the couple. She had a life expectancy in excess of 20 years, her husband was expected to predecease her and the residual assets were expected to go to the adult children. Sounds like a simple evaluation. If the benefit was expected to go to the spouse, then there would be no recontribution strategy. The logic is that the spouse pays no tax and so the maximum anti-detriment payment is desirable. On the other hand, adult children who do pay 15% on the taxable component will find the recontribution strategy produces a better result.
Here comes the problem. The gain for the adult children from the recontribution strategy was modest – but the potential loss if the benefit went to the spouse was about four times that amount. Maths (you might think) could still rule. We could weight the two outcomes by their relative probabilities and the gain or loss. However, this does not cover that “feeling” that the retired spouse would need the funds while the benefits would be less required by high earning adult children beneficiaries. I suspect that if it were my decision, in this particular case I would not have done the recontribution strategy – even though (from a Maths perspective) it was the right thing to do. It’s the classical behavioural economics decision between a likely small gain versus avoidance of a less likely, but larger, loss outcome.
The NetActuary Team