Bruce Brammall, 7 March, 2018, Eureka Report
SUMMARY: Transition to retirement still makes sense. And not doing so, for some, would be like leaving money lying around on the ground.
Some of the fun in transition to retirement pensions was surgically removed last year. But not all of it.
TTR strategies are still a strategy worth considering for many. There are some for whom it still works beautifully – though a little less beautifully than it once did.
And there are others for whom it no longer makes much sense. The government is collecting tax where it did not previously. And the tax burden, in some cases, will have turned the once-mighty strategy into something more marginal.
The earthquake for TTRs occurred on 1 July 2017. From that date, for the first time, TTR pension funds would be taxed as if still in accumulation phase.
The decision to tax TTRs was taken because they were no longer being used for their “true” purpose. They were initially designed by the Howard Government to allow people to reduce their working hours, without taking a pay cut, by beginning to draw from their superannuation as a pension income stream.
However, it was quickly discovered that they were simply a great tax dodge, allowing people to recycle money through super and reduce their overall tax. People over 60 could draw a tax-free pension income stream while still working, then salary sacrifice (or make other concessional contributions) to complete a low-tax merry-go-round.
It was a strategy that could add thousands of dollars a year to your overall super benefit – even tens of thousands of dollars when CC limits were $100k or $50k.
But where are we now?
TTR pensions now paying tax, at either 15% for income and an effective rate of 10% for capital gains.
But it’s not all a disaster. It can still make sense in many circumstances.
Who can still benefit? Those with small to middling super fund account balances. And those whose cashflow wouldn’t allow them to salary sacrifice without drawing a TTR pension.
Today, I want to take you through two examples of how the taxing of TTR pensions has changed the strategies considered.
Example 1: small super account balance
First up, we have a 60-year old earning $60,000 a year, with a super fund balance totalling $200,000. She doesn’t have a lot of spare cash once expenses are paid.
By turning her super fund into a pension, she will be able to draw up to $20,000 (TTRs must draw between 4% and 10% of their pension fund as an income stream) in pension income from the fund.
This will in turn allow her to make concessional contributions back into super – most have traditionally done that by salary sacrifice, but see below.
Note: No-one needs to be restricted by salary sacrifice anymore. It used to be the case that if you earned more than 10% of your salary as an employee, you could only get extra money into super via salary sacrifice. However, they have removed the 10% rule now, so anyone can make a tax deductible contribution to super at any time of the year.
She’s receiving $5700 in Superannuation Guarantee payments from her employer, meaning she has $19,300 left to contribute to super under the $25,000 CC cap.
As she’s over 60, she can draw the $19,300 pension tax-free from her super on, say, 1 June. She could then re-contribute it straight back into super in June. This would give her a $19,300 tax deduction on her income.
She would receive a tax return of $6658.50 ($19,300 x 34.5%) from her tax-deductible contribution. On her contribution of $19,300 to her super fund, she would pay $2895 in contributions tax as it went into super.
This still leaves her $3763.50 ahead, with no cashflow impact.
It’s like picking up money left lying around on the ground.
The main “loss” in this situation, from the old rules, is that the super fund would previously not have been paying income or capital gains tax on the fund’s earnings. For a $200,000 fund, earning, say, 5% in income and 2% in capital gains, there is a real benefit lost here. But no-one should confuse that with the still real benefit received from the strategy of taking the tax-free income stream and making further deductible contributions.
Example 2: Larger super balance, larger income
Employee earning $200,000 a year, with a super balance of $1 million. He is saving money from his income.
This employee is already receiving $19,000 in SG payments from his employer, leaving him the ability to put in just $6000 a year as further CCs to remain under the $25k cap.
If he turned the entire pension into a TTR, he would have to draw a pension of 4-10% of the balance, or $40,000 to $100,000.
In this case, drawing down the pension income (while tax free) would create income that he couldn’t really get back into super tax effectively. This person could probably simply make a tax-deductible contribution from savings to super of $6000 to get him up to the $25,000 CC limit and not have to draw on his super.
However, a strategy worth considering might be to draw the income and then recontribute it as a non-concessional contribution. While the tax saving, up front, would be nil, it would help change the taxable component of his super, in the event that he dies and the money is left to non-dependents, such as adult children. Done over a number of years, if there are no dependents to leave his super to, he can save considerable amounts on tax in the event of his death.
It would become a strategy, over many years, of decreasing the taxable portion of his super and increasing the tax-free portion. This is a strategy more around estate planning, but still something to consider by everyone in this sort of position.
If this person was considering making considerable NCCs to his super fund with other savings, then drawing the pension might only have the impact of reducing his overall super lump sum.
Result: Only with consideration of this person’s broader circumstances could a strategy be devised here to reasonable effect.
The real “losers”, of course, from the changes are those who were already using the strategy and were benefiting from having had their pension fund already being tax free. Their funds now have to pay tax on the funds’ earnings. The bigger the fund was, the more tax they are now paying.
But it doesn’t mean there isn’t still tax savings to be made. It will just be less, but might still be worthwhile.
And please don’t forget the best solution to this issue: if you’re able to turn your TTR into an ABP, then that is the best strategy to adopt. If you’ve changed jobs after turning 60, or retired for a period, then this will be enough to also have your TTR pension fund stop paying tax.
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: firstname.lastname@example.org . Bruce’s sixth book, Mortgages Made Easy, is available now.