Making sense of new transition to retirement rules
Here we examine the potential impact for SMSF investors of the new rules around transition to retirement (TTR) pensions which are changing from 1 July.
Since 2007 some self-managed super fund (SMSF) members have been able to enjoy tax-free investment income from transition to retirement (TTR) pensions. From 1 July, rules around TTRs will change and it’s important for SMSF investors to understand the potential for this to impact them.
Greg Einfeld, director, Lime Super, says changes to the TTR scheme are the least understood of all the modifications the federal government has recently made to the superannuation system.
“People are not across these changes, but they affect a large number of people and have the potential to have a significant financial impact,” he says.
TTR pensions were created to allow people in their late 50s and early 60s to reduce their working hours and supplement their income from their superannuation.
“But TTRs are used most frequently as a tax planning strategy, and commonly by people who are not reducing their work hours. By removing the tax benefits of TTRs, they will now only be used for their original purpose,” Einfeld explains.
He says it still makes sense to keep a TTR pension in place for super fund members who rely on the income from the TTR to meet their spending needs.
“But additional tax will be payable by the member when they receive their pension income, unless they earn less than $37,000 a year,” Einfeld explains.
Damian Liddell, a financial adviser with Browell’s Financial Solutions, agrees new rules mean transition to retirement strategies are now less attractive for pre-retirees. But he says there are other reasons why keeping a transition to retirement strategy may still be beneficial for SMSF members.
“You might keep a TTR strategy if the member pays a high personal tax rate. They might also make sense if the member is older than 60 years of age, the age when pension payments become tax-free, and if they are also on a medium to high personal tax rate,” says Liddell.
Peter Hogan, the Self-Managed Super Fund Association’s head of technical, says it may make sense for people on a high marginal tax rate to continue to use a TTR if they really are still working, but are cutting back the hours they work and are still looking to subsidise the difference between what they would earn five days a week, opposed to what they're going to earn three days a week.
“That's the only real reason why someone might continue with that strategy. Because otherwise, when you look at the numbers, the limits on the concessional contributions and the fact there's no tax exemption at the fund level from 1 July, it may not make sense. But if you do have one, don't stop it until after 1 July to continue to receive the tax benefits of the existing system,” he explains.
Einfeld says most people earning more than $37,000 who are receiving a TTR pension should consider commuting the fund back to the accumulation phase on 1 July 2017.
“This way, they will be able to leave more money in super for longer, without paying any tax if they wait until they are retired or older than 65 when they ultimately take money out of the super system.”
If the member has retired or turned 65 since they commenced their TTR pension, they can convert that pension to an account-based pension and retain the tax benefits they currently enjoy.
There are other considerations SMSF investors need to make alongside the new TTR rules. As Liddell notes, it’s also important to be aware concessional contribution caps are being reduced to $25,000, so you won’t be able to put as much into super after the changes come into force.
“Before starting a TTR strategy you need to calculate how much of your concessional contribution cap is not being used, remembering employer super contributions count towards the cap,” he notes.
While the rules are changing, having a TTR strategy for the purposes of saving tax will still be beneficial in some circumstances – just not as much as it may have been in the past.
If you currently have a TTR strategy attached to your SMSF, it’s important to check that it still works for you before the new rules come into effect next year.