By Liam Shorte 10 Sep 2015

The benefits of a transition to retirement strategy

If you’re eligible for a transition to retirement (TTR) pension but don’t have one, it could be costing you money. We explain why.

Snapshot

  • What is a TTR pension?
  • The financial benefit of a TTR pension explained
  • Key issues to take into account

If you are over 55 and haven’t considered a transition to retirement (TTR) pension then you might be missing an opportunity to significantly boost your retirement savings. Let’s explain why.

Background

Once you reach your preservation ageThe age at which you can generally access your super (subject to satisfying a condition of release). A person's preservation age depends on their date of birth. For those born before 1 July 1960 it's 55, but it will gradually increase to 60 over coming years. See the ATO website for more information. (at least 55, but it depends on your date of birth) you can use a TTR pension to access your superannuation while you are still working. This may be particularly attractive if you have reduced your working hours and need to top-up your income to maintain your standard of living. It’s also popular as a strategy to maintain your overall level of income, while reducing tax.

The aim of the TTR rules is to provide you with flexibility in the lead up to retirement and you can start a TTR whether you’ve got an SMSF, or you’re a member of an external super fund.

What is a TTR pension?

TTR pensions are just like normal account based pensions, but with two important differences.

Firstly, they are non-commutable, which means they cannot be converted into a lump sum until you satisfy a condition of release, such as retirement or age 65.

Secondly, you have the normal minimum payment amounts you must withdraw each year, but you also have a maximum; each year you can only withdraw up to 10 per cent of the account balance (at 1 July).

TTR pensions are taxed the same as regular pensions. If you are under the age of 60, the taxable part of your pension will be taxed at your marginal rate, but you receive a 15 per cent tax offset if your pension is paid from a taxed source (which will typically be the case). Once you reach 60, your pension is tax-free (if paid from a taxed source); you don’t even have to include it in your tax return.

Best of all, while taking a TTR pension you can still contribute to your super fund (so long as you’re eligible to contribute) and your employer’s usual superannuation guarantee obligations still apply. However, you need to have an accumulation account to pay these amounts into as you cannot add to a pension account.

Let’s take a look at how a TTR pension, combined with salary sacrifice, can be used to improve your after-tax savings.

Example: Salary sacrifice combined with TTR pension

Meet Tamika, who’s 57 and is on a salary (before compulsory super contributions) of $80,000, with $200,000 in super. She has no intention of retiring and is now focused on saving for her retirement. Her living expenses are $50,000 a year, which gives her a savings capacity of $10,853 a year after tax and compulsory super contributions.

The following options would see Tamika ending up with the same net take home amount of $50,000 per annum (after taxes):

  • Option 1: She makes a non-concessional (after-tax) contribution of $10,853 to her super fund (or simply saves this amount) or;
  • Option 2: She salary sacrifices up to her $35,000 concessional cap limit (the the limit that applies to those aged 49 or over). After allowing for her employer contributions of $7,600, she can salary sacrifice $27,400 of super contributions. She also starts a TTR pension, drawing a pension payment of $8,812 annually. This will allow her to maintain her $50,000 take home pay and end up with an extra $5,125 in her super account (based on assumptions below).

Table 1 shows how the TTR strategy helps reduce tax, while maintaining the same take home pay. The impact on Tamika’s super account is shown in Table 2.

Note: Most employers will pay compulsory super on the salary sacrifice component of the employee’s salary package (so you don’t lose out by salary sacrificing super). But you should check with your employer first.

The TTR strategy will provide a benefit to most people. However, sometimes it won’t make sense for high-income earners aged under 60, whose super account doesn’t have a high tax-free component. In this case, the benefit of switching the super account to pension mode can be exceeded by the cost of having to pay tax on the TTR pension.

However, it’s a case by case proposition as a large tax-free component or one-off capital gainThe profit that an investor makes when they sell an investment or (if unrealised) the profit they would make if they sold the investment for its value at that time. may make the strategy worthwhile, despite the tax on the pension payment.

How do you start a TTR pension?

If you’ve worked out a TTR makes sense for you, the obvious next question is ‘how do I start?’

Fortunately, it’s pretty simple. If you’re with an external super fund, once you meet your preservation ageThe age at which you can generally access your super (subject to satisfying a condition of release). A person's preservation age depends on their date of birth. For those born before 1 July 1960 it's 55, but it will gradually increase to 60 over coming years. See the ATO website for more information. you just need to complete a pension application for your fund and tell them you wish to start the pension, if it is to be reversionary or not, what pension amount you wish to receive and if the payment is required monthly, quarterly or annually.

Many funds can now roll over your existing investments to pension mode (although check with your fund first). It’s also a good idea to review your asset allocationThe way you spread your portfolio among different types of investments (asset classes). For example, if you had $10,000 to invest you might decide on an asset allocation consisting of 50% term deposits and 50% shares. and risk tolerance at this stage.

If you have an SMSF then you need what is referred to as a ‘Pension Kit’ and it follows the same process – application, initial agreement by trustees documenting the pension, providing the Product Disclosure Statement and a finalised pension agreement once the annual financials of the fund have been completed (see Transitioning to retirement? Shift your super into pension mode for more details).

Is a TTR pension right for you?

TTR pensions can provide you with flexibility in the years leading up to your retirement and, depending on your circumstances, can help to boost your retirement savings.

People who might find TTR pensions attractive include those who have reduced their working hours from full time to part time (for instance, only working three days a week) and those who are able to salary sacrifice to superannuation. In both cases, the reduced salary is topped up with the income from the TTR pension.

The same rules apply to a self-employed person making personal concessional contributionsThe 'normal' contributions made to your super account. Concessional contributions include compulsory contributions made on your behalf by your employer, voluntary contributions made out of your salary package and cash contributions by self-employed people (who are entitled to a tax deduction for it). Concessional contributions are either made from 'pre-tax' income or are tax deductible. See the ATO website for more information. rather than salary sacrifice.

The transition to retirement rules and associated strategies can be very complicated so we recommend seeking personal advice on your situation before proceeding. 

 

Liam Shorte is a principal of Verante Financial Planning Pty Ltd (www.verante.com.au), a corporate authorised representative of Magnitude Group Pty Ltd (AFSL 221557). This article is a general information article and to the extent it contains any financial advice it is general advice only. We recommend seeking personal advice on your own circumstances.

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