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Tax effective transitioning
- By Tara Jones
- Published 8/10/2009
- Spring/Winter 09
- Unrated
Tax effective transitioning
Transition to retirement (TTR) is not a new concept, it has been an option for super fund members since 1 July 2005. However, in the current environment, the strategies that exist around this concept continue to be attractive.
There is no doubt that over the last two years sharemarkets around the world have had a significant impact on the value of household wealth. Equity markets fell up to 50 per cent leaving investor sentiment very negative and investor emotion riding a roller coaster as the markets continued to rise and fall. However, even in such unprecedented times, investing in equities through your superannuation is not a lost cause. We know, as disciplined long term investors, that markets will recover and that by investing into a diversified portfolio we will be positively rewarded for the level of risk that we take. As we have previously highlighted there is a very effective strategy out there which will complement positive market returns and help claw back superannuation losses at a greater pace.
This strategy centres on the TTR concept. An effective TTR strategy is available for anybody between the ages of 55 and 65 and has two main elements. The first centres around the pension that is established and the tax benefits attached to it. The second combines the tax effective pension with a salary sacrifice arrangement, which often results in you contributing more super than you are taking out. But before we go into the specifics, let’s recap on some of the general principles of TTR and how it works.
Transition to retirement
Before 1 July 2005 individuals could only access their accumulated superannuation benefits if they had met a condition of release such as permanently retiring after reaching preservation age, or simply turning age 65.
In order to encourage older Australians to remain in the workforce for longer, the Government introduced legislation that allows people to remain working, but ‘transition to retirement’ slowly by reducing full-time employment without necessarily reducing their income. Therefore a ‘transition to retirement’ condition of release was established. This enables anyone who has reached their preservation age to access their superannuation savings as a regular income stream, without having to leave their job or retire from the workforce.
To be eligible to take advantage of this opportunity there are two important conditions that must be met. The first, and as touched on above, is that you need to have reached your preservation age, which for anyone born before July 1960 is 55 and scales up to 60 for those born in each of the subsequent years. This is the age at which you can commence an income stream.
The second condition is that you must use your accumulated benefits to commence an income stream called a ‘non-commutable’ pension, or as we will refer to it, a TTR pension. The words ‘non-commutable’ impose a special withdrawal restriction being that you cannot draw a pension that is greater than 10 per cent of your account balance at 1 July each year. Therefore, between the ages of 55-64 you need to draw an annual pension of at least the legislative minimum being 4 per cent (currently halved under special rules to 2 per cent ), but no more than the maximum of 10 per cent.
So provided you have reached your preservation age, you can establish a TTR pension, which in its original form, allows you to ease into retirement. But what else is it about setting up a TTR pension that makes them so attractive?
When you start a pension it immediately triggers a chain of tax concessions. If you are between age 55 and 60 there is a 15 per cent tax rebate available on the assessable portion of the pension and once you turn 60, the pension becomes completely tax-free and non-assessable. Non-assessable means it will not be included in your tax return and therefore any other income you have will potentially be taxed at a lower rate as well. In addition, all the earnings (dividends, rent, interest etc and capital gains) within the pension account are also tax free, which compares to accumulation mode, where earnings are generally taxed at 15 per cent. Once you reach age 65, or meet another condition of release prior to turning 65, the 10 per cent restriction on withdrawals drops off.
Adding some more complex strategies by linking a TTR pension with an effective salary sacrifice arrangement further enhances the tax effectiveness and maximises your ability to improve your superannuation position, which in this environment will help recoup paper losses more quickly.
Salary sacrificing into superannuation is the process where you elect not to receive some of your income, and instead have your employer contribute this amount into superannuation on your behalf. Therefore, in this instance you may not change your working arrangements, but instead simply take advantage of a strategy that allows you to save pre-tax dollars by contributing salary into superannuation and then draw on a tax effective income from your already accumulated benefits.
The amount salary sacrificed into super will be taxed at only 15 per cent instead of your marginal tax rate, and as it is not included in your taxable income has the ability to pull you down a tax bracket or two and therefore, can have a similar effect as pension income after age 60, being that less tax could be paid on other income as well.
To compensate the forgone salary income, you establish a TTR pension, which as mentioned above, will attract either a 15% offset, or it will be received tax-free if you are over the age of 60. Therefore, the level of pension income you will need to draw down in order to leave you in the same after tax position as status quo is generally less than the net amount contributed to superannuation. More is going in than is coming out, enhancing your wealth.
This strategy can be very effective and provide significant benefits. However, it will not work for everyone and it needs to be assessed on an individual basis. While in almost all circumstances there will be benefits for those aged 60 and over, it is not so clear cut between the ages of 55 and 60. In any instance, a number of variables need to be considered (account balance, tax free components, age, salary etc) to determine its appropriateness. If you think it might work for you. Please contact one of our advisers who can discuss your situation with you.
Transition to retirement (TTR) is not a new concept, it has been an option for super fund members since 1 July 2005. However, in the current environment, the strategies that exist around this concept continue to be attractive.
There is no doubt that over the last two years sharemarkets around the world have had a significant impact on the value of household wealth. Equity markets fell up to 50 per cent leaving investor sentiment very negative and investor emotion riding a roller coaster as the markets continued to rise and fall. However, even in such unprecedented times, investing in equities through your superannuation is not a lost cause. We know, as disciplined long term investors, that markets will recover and that by investing into a diversified portfolio we will be positively rewarded for the level of risk that we take. As we have previously highlighted there is a very effective strategy out there which will complement positive market returns and help claw back superannuation losses at a greater pace.
This strategy centres on the TTR concept. An effective TTR strategy is available for anybody between the ages of 55 and 65 and has two main elements. The first centres around the pension that is established and the tax benefits attached to it. The second combines the tax effective pension with a salary sacrifice arrangement, which often results in you contributing more super than you are taking out. But before we go into the specifics, let’s recap on some of the general principles of TTR and how it works.
Transition to retirement
Before 1 July 2005 individuals could only access their accumulated superannuation benefits if they had met a condition of release such as permanently retiring after reaching preservation age, or simply turning age 65.
In order to encourage older Australians to remain in the workforce for longer, the Government introduced legislation that allows people to remain working, but ‘transition to retirement’ slowly by reducing full-time employment without necessarily reducing their income. Therefore a ‘transition to retirement’ condition of release was established. This enables anyone who has reached their preservation age to access their superannuation savings as a regular income stream, without having to leave their job or retire from the workforce.
To be eligible to take advantage of this opportunity there are two important conditions that must be met. The first, and as touched on above, is that you need to have reached your preservation age, which for anyone born before July 1960 is 55 and scales up to 60 for those born in each of the subsequent years. This is the age at which you can commence an income stream.
The second condition is that you must use your accumulated benefits to commence an income stream called a ‘non-commutable’ pension, or as we will refer to it, a TTR pension. The words ‘non-commutable’ impose a special withdrawal restriction being that you cannot draw a pension that is greater than 10 per cent of your account balance at 1 July each year. Therefore, between the ages of 55-64 you need to draw an annual pension of at least the legislative minimum being 4 per cent (currently halved under special rules to 2 per cent ), but no more than the maximum of 10 per cent.
So provided you have reached your preservation age, you can establish a TTR pension, which in its original form, allows you to ease into retirement. But what else is it about setting up a TTR pension that makes them so attractive?
When you start a pension it immediately triggers a chain of tax concessions. If you are between age 55 and 60 there is a 15 per cent tax rebate available on the assessable portion of the pension and once you turn 60, the pension becomes completely tax-free and non-assessable. Non-assessable means it will not be included in your tax return and therefore any other income you have will potentially be taxed at a lower rate as well. In addition, all the earnings (dividends, rent, interest etc and capital gains) within the pension account are also tax free, which compares to accumulation mode, where earnings are generally taxed at 15 per cent. Once you reach age 65, or meet another condition of release prior to turning 65, the 10 per cent restriction on withdrawals drops off.
Adding some more complex strategies by linking a TTR pension with an effective salary sacrifice arrangement further enhances the tax effectiveness and maximises your ability to improve your superannuation position, which in this environment will help recoup paper losses more quickly.
Salary sacrificing into superannuation is the process where you elect not to receive some of your income, and instead have your employer contribute this amount into superannuation on your behalf. Therefore, in this instance you may not change your working arrangements, but instead simply take advantage of a strategy that allows you to save pre-tax dollars by contributing salary into superannuation and then draw on a tax effective income from your already accumulated benefits.
The amount salary sacrificed into super will be taxed at only 15 per cent instead of your marginal tax rate, and as it is not included in your taxable income has the ability to pull you down a tax bracket or two and therefore, can have a similar effect as pension income after age 60, being that less tax could be paid on other income as well.
To compensate the forgone salary income, you establish a TTR pension, which as mentioned above, will attract either a 15% offset, or it will be received tax-free if you are over the age of 60. Therefore, the level of pension income you will need to draw down in order to leave you in the same after tax position as status quo is generally less than the net amount contributed to superannuation. More is going in than is coming out, enhancing your wealth.
This strategy can be very effective and provide significant benefits. However, it will not work for everyone and it needs to be assessed on an individual basis. While in almost all circumstances there will be benefits for those aged 60 and over, it is not so clear cut between the ages of 55 and 60. In any instance, a number of variables need to be considered (account balance, tax free components, age, salary etc) to determine its appropriateness. If you think it might work for you. Please contact one of our advisers who can discuss your situation with you.
Article Series
This article is part 6 of a 6 part series. Other articles in this series are shown below:
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Tax effective transitioning