Pension now, not so fast

Bruce Brammall, 1 August, 2018, Eureka Report

SUMMARY: Should you turn on a super pension? Not the simple question it used to be.

You’ve hit round about that age and your super is sort of hanging out there like a ripe fruit ready to pluck off the tree.

But just because it’s there, do you necessarily pick it?

The decisions and strategies around turning on a pension have never been more complicated.

Pensions have become, overall, less appealing. The law changes in recent years have turned transition to retirement on its head and the $1.6 million limit on tax-free pensions have changed strategies for many also.

To the point where the balance of attention has swung back to accumulation and getting money into super, rather than strategies on how to get it out.

But super pensions are still the end game. The path to get there is just a little less smooth.

So what’s changed? There have been two main changes that have diluted the attractiveness of turning on pensions. But I’ll show you where they still make sense.

Transition to retirement – attaining preservation age

For a start, in order to take a TTR pension, you need to have reached “preservation age”.

The slow, legislated, increased to preservation ages kicked up a year again on 1 July this year. People who turn 57 in the current financial year will hit their preservation age. But, because of the new tax on pension funds, it will less often make sense to take a pension, unless you require the income.

Transition-to-retirement funds

Prior to 1 July last year, all funds in pension-phase were tax free, no matter what they were for, or their size.

But now transition-to-retirement pension funds are taxed, as if in superannuation mode. That is, they pay 15% tax on income and an effective rate of 10% on capital gains.

Take a $500,000 fund, earning 4% income and making taxable capital gains of 2% for a year (as in CGT events occur). That’s $20,000 in income and another $10,000 in capital gains.

Prior to July 2017, no tax. But after that, this fund would be up for around $3000 a year in income tax and $1000 in CGT, paid inside the fund.

If you were on a TTR pension for, say, five years, before qualifying to switch to an account-based pension, the extra tax adds up.

The tax-free nature of the TTR pension fund was a big part of the benefit or sales pitch to implement the strategy.

The benefits were further diluted if you were under 60 and still had to pay some tax on the pension you drew from the fund. Those who are over preservation age, but under age 60, get a 15% tax offset on the income they draw from the pension.

Where do they still make sense?

But TTRs still make sense for some. From a tax perspective, taking a pension under the age of 60 has become more marginal in most cases. But if the member requires the income to fund lifestyle, then that will be reason enough.

If you’re over 60, pension payments become tax free. If you have a relatively small super balance and lower income, then it can make sense to draw a pension if it will help to give you enough cash flow to increase your super contributions.

Draw the pension tax-free, but recontribute it back into accumulation. Whatever you can do to draw the least from your pension fund, while trying to maximise your concessional contributions up to the $25,000 limit.

For example, a 60-year-old, earning $60,000 a year, with $200,000 in super. She could draw between $8000 and $20,000 (4-10%) in a TTR pension.

She is already getting $5700 in Superannuation Guarantee Contributions, so she has space to contribute another $19,300 a year.

If she draws that $19,300 from her pension fund and contributes it back to super as a concessional contribution, she will get a tax deduction for that contribution.

The contribution will lose 15% on the way into super ($2895), but will generate a tax deduction for her, netting her a tax return of $6658.50. That will leave her about $3763.50 ahead.

However, if someone with a large super fund – say $1 million or more – had to draw a TTR pension of between $40,000 and $100,000, then this strategy probably wouldn’t make sense, particularly if they also earned enough to meet their needs and were already contributing, or capable of contributing, up the maximum in CCs.

Larger funds, larger wealth. Do I turn on pension?

Having more than $1.6m in super now also comes with a question about whether you turn on a pension or not.

If you turn on a pension, you have to draw down on it, at a minimum of 4%, rising as you age. Sure the pension fund earns income and gains tax free and the pension drawn is tax free for the over 60s.

But is it best to take money out of this low-tax environment if you’ve still got money outside of super you’d be better off spending? Knowing that once the money is brought outside of super, it can be difficult to get back in, particularly for the over 65s?

If you have considerable savings or investments outside of super, it can make sense to spend down that personal, non-super, money, which is being taxed at up to 47%.

Those with considerable sums outside of super (say, more than a million or so) might need to examine whether to keep their entire savings inside superannuation accumulation, where it is taxed at only 15% and where you don’t have to draw an income.

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The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is managing director of Bruce Brammall Financial and is both a licensed financial adviser and mortgage broker. E: bruce@brucebrammallfinancial.com.au . Bruce’s sixth book, Mortgages Made Easy, is available now.