Can transition to retirement strategies still work?
Transition to retirement (TTR) pensions were first introduced to assist people making the change from full-time work to part-time work.
They were put in place to allow people near retirement to start drawing some money out of their super fund to supplement their reduced income, as they wound their working hours and income back.
Until now, investment income associated with TTR pensions has been tax-free. But from 1 July this year investment income associated with TTR pensions will no longer be exempt from tax.
Generally, says Greg Einfeld, principal of self-managed super fund (SMSF) specialists Lime Super, SMSF members have TTR pensions in place for one of two reasons.
“It’s either to reduce tax or because they rely on a regular income stream from their super,” says Einfeld.
Although not their original purpose, tax minimisation has become the most common reason for starting TTR pensions. Consequently, the federal government has decided to remove the tax exemption to encourage people to use TTRs to supplement their income, rather than reduce their tax bill.
Einfeld says from 1 July this year SMSF members who have TTR pensions only for tax purposes would generally be better off commuting those pensions. This means the fund would be converted back to the accumulation phase.
“This will allow members to leave more money in their super funds. However, members who need an income stream from their super account to fund their lifestyle should leave their TTR pensions in place,” he adds.
Damian Liddell, a financial adviser with Browell’s Financial Solutions, agrees a TTR strategy in its purest sense still works for people who want to access their super to supplement a reduced salary.
“But for tax savings, a TTR strategy will become a lot less effective. Earnings at the fund level will now be taxed at 15%,” he adds.
Also, it’s likely for people who are employed, the majority of the $25,000 concessional cap will be taken up by employer superannuation guarantee payments.
“For people aged between 56 and 59 a TTR strategy really isn’t going to be worth it because the pension payments will be taxable, less the 15% tax offset,” says Liddell.
“So for these people, while there may be some tax saving, it’ll be minimal,” he adds.
It’s useful to use a case study to understand how a TTR works in practice. Let’s assume Sharon, 61, has approximately $1.5 million in super, all in a TTR pension.
Sharon is still working and earns $80,000 a year. She has assets of $3 million outside super and would like to contribute as much as she can into her super fund.
It’s expected her SMSF will earn a 6% return on the $1.5 million in the fund a year, which equals $90,000. At present Sharon benefits from having a TTR because the fund pays no tax on this income.
After the new laws take effect in July the fund will pay $13,500 tax a year (15% of $90,000), no matter whether the fund is in accumulation or pension phase.
“So there is no direct tax benefit of her having a TTR. But by continuing the TTR she will be required to withdraw $60,000 from super each year. Ideally, Sharon should keep as much as possible in super, and she can do this by commuting her balance to accumulation phase,” Einfeld explains.
Liddell says a TTR strategy is still worthwhile for people older than 60 on mid-range incomes, say $100,000.
“In this instance the member would still be able to contribute $15,000 on a concessional basis, after allowing for employer super guarantee payments. It could still make sense for people in this situation to use a TTR strategy. Salary sacrificing $15,000 a year would reduce the member’s tax bill by around $3,500 a year,” he says.
Moreover, Liddell says TTR strategy still makes a lot of sense for someone over the age of 65 who is still working.
“For these people, earnings at the fund level would be taxed at zero rather than at 15%,” he adds.
If you have a TTR pension it may be worth seeking advice to ensure it still makes sense after 1 July.