Pension hazard ahead: Act now

SUMMARY: It’s not too late for transition-to-retirement pensions to be updated to tax-free account-based pensionss. Here’s how.

For a year, it has felt like we’ve been madly running a race that finishes on 30 June at midnight.

For many, that was the case. A year-long marathon, with a sprint finish. And a new, longer but slower, marathon started on Saturday morning 1 July.

But 30 June is not the end of anything really. For most of you reading this, it will simply be a point marker in time, when a few rules have changed, and starting the beginning of some real work. Some big decisions.

Some of those decisions, which I will return to in coming weeks, include applying for capital gains tax relief and which assets to keep in your pension fund.

One of the biggest affected groups will be those on transition to retirement (TTRs) pensions.

According to peak industry body ASFA (the Association of Superannuation Funds of Australia), there are 270,000 Australians who are on TTRs, either through SMSFs or APRA-regulated funds.

TTRs are those pension income streams started by people who have not yet met a condition of release, but who have reached preservation age and are able to draw a pension of between 4% and 10% from their super fund.

From 1 July, 2017, TTR pension funds will be taxed, inside the fund, for the first time. (If you are over 60, you will still receive any pension payments tax-free. But your fund itself will have to pay tax on earnings and gains.)

And what does it mean for them to be taxed from 1 July?

Let’s take a $500,000 TTR pension fund. It is earning taxable income of 7% a year, from a combination of sources, including dividends, interest and rent and some discounted capital gains. Of this $35,000 in income, it needs to pay tax at 15%. That’s $5250 in new tax the fund will have to pay each year, from 1 July onwards.

Why has the government done this? Because TTRs were not being used for the purpose for which they were intended, which was to allow older Australians to reduce their working hours.

Instead of Australians supplementing their incomes with a TTR pension as they shifted from, say, 5 days to 4 or 3 days … TTR pensions, combined with salary sacrifice, had simply become a way to minimise tax and maximise superannuation via salary sacrifice in the lead-up to retirement.

(Hey, those using the system didn’t invent the rules. They were just making the most of them.)

As a result, successive governments have been chipping away at the effectiveness of TTRs. And this one is close to the final straw. It will, for a considerable number of people, make TTRs line ball, if worthwhile at all.

Many will, or should, decide to stop their TTR. And, as a result, roll back their TTR pension to accumulation. While they will be paying 15% earnings on the fund that has been rolled back, they would not have to withdraw between 4% and 10% of their pension fund each year.

The trick to maintaining the status quo

Until 1 July, the main difference between a TTR and a regular account-based pension (ABP) was that with a TTR, you were limited to taking 10% of your fund as an income stream. With an ABP, you gain unrestricted access to your pension.

But with the introduction of taxation of fund earnings, TTRs and ABPs become markedly different. And it becomes highly important, therefore, that if you are able to switch your TTR into an ABP, that you should.

How can this be done?

A TTR is started by someone who has reached preservation age, but has not yet ceased work. They have not met a condition of release.

However, many who start a TTR later meet a condition of release. They might not realise they have done so. And, prior to 1 July, 2017, it didn’t really matter, as there was no change in tax consequences.

You can change your TTR pension into an ABP if you have met a suitable condition of release. Even if that happened a number of years ago.

For the purpose of this example, let’s talk about the three main “conditions of release”.

Turning 65. The ultimate condition of release.

1. Turning 60 and ceasing an arrangement of gainful employment.
2. Reaching preservation age and permanently retiring from the workforce.

Because of the new taxation of TTRs, it is important for you to make sure your super fund knows that you have met a condition of release. It needs to be noted and accepted by the fund’s trustees.

If you have turned 65, there should be no need to worry from 1 July. Your super fund should automatically change your TTR pension to an ABP. No further taxation.

However, if you are on a TTR pension and met a condition of release some time after that, your super fund won’t necessarily know that you have qualified to switch your TTR into an ABP. And you are about to have your fund taxed unnecessarily.

For example, you turned on a TTR pension on your 60^th birthday. A couple of years later, you changed jobs, or were made redundant, but found another job fairly quickly.

If you end an employment arrangement after age 60, you are eligible to have your funds turned unrestricted non-preserved and, therefore, have your TTR turn into an ABP.

Similarly, if you have reached preservation age (see table below) and are permanently retired from the workforce, or never intend to work more than 10 hours a week again, you can also qualify to have your benefits moved restricted to unrestricted non-preserved and to have your TTR switched to an ABP.

For those with SMSFs who are being provided with personal tax advice, this is something your advisers should be raising with you. “Have you, at some stage, hit a trigger that could stop your super fund being taxed?”

However, if you are in an APRA-regulated fund, particularly if you don’t have an adviser, you are highly unlikely to get a phone call to discuss your situation. If you’re lucky, you’ll get a generic letter. Which you will probably ignore. Because it will be poorly worded and it won’t look like it relates to you.

The advice to the super fund can be of a historical nature – that is, if it happened some years ago, you can still apply to have your super fund status changed, even if you are now fully back in the workforce.

Contact your super fund (or your adviser) and ask them what sort of paperwork or proof they require that you changed jobs.

The bigger your TTR fund, the more tax you will save by getting these details to them sooner rather than later.

If you need help, call our office on 03-9020-2905.

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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 new book, Mortgages Made Easy, is available now.