By Liam Shorte and Ben Smythe 10 Jun 2015

Transitioning to retirement? Shift your super into pension mode

If you’re aged 55 or older, you might want to start a transition to retirement (TTR) pension. Liam Shorte and Ben Smythe explain how.

Snapshot

  • You can take a TTR pension once you’ve reached your preservation age (55 and up)
  • For most people, it’s a good idea
  • We explain why and what you need to do

You’ve spent years, possibly decades building up your super and you’ve finally hit the tender age of 55 (the current 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.). It’s time to think about switching your SMSF to ‘pension mode’.

Note: from 1 July this year, the 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. will increase to 56 and keep increasing each 1 July until it reaches 60 at 1 July 2020.

First cab off the rank, when it comes to super pensions, is the transition to retirement pension (TTR). Unlike a ‘regular’ account based pensionThe 'usual' superannuation pension you receive on retirement. Your account contains an amount from which you can make withdrawals (subject to set minimums). These withdrawals (the pension) are generally tax-free for those over 60. (ABP) a TTR strategy can begin while you’re still working.

Both an ABP and TTR require you to make minimum withdrawals. However, a TTR has an added restriction: you’re not allowed to withdraw more than 10 per cent (based on opening account balance) each year.

Should I take a TTR?

The benefit of taking a TTR is that it puts your super account into pension mode. If you’re under 60, you’ll be taxed on the taxable component of the TTR pension payment at your marginal tax rateYour marginal tax rate is the tax rate that applies to the last dollar of your income. Australia has a progressive tax system where the marginal tax rate applied to individuals increases as your taxable income decreases. Current individual tax rates can be found at the ATO website., but with a 15 per cent tax offset (credit). If you’re 60 and over, the pension is tax-free.

A TTR strategy makes most sense when drawing a pension allows you to make a larger salary sacrifice (or deductible) contribution to super (see ASIC’s Moneysmart example). This way you’re effectively reducing your personal tax (due to the tax offset), maintaining (or growing) the balance of your super account and paying no tax on it. But a TTR pension can also be used to reduce your working hours, whilst maintaining your income (see example).

Taking a TTR makes sense for most people, although it’s not for everyone. For example, if you’re a high income earner and your super doesn’t have a large tax-free component (which isn’t subject to tax), you may get a better financial outcome leaving your super account in accumulation.

We often find people earning more than $200,000 (and already salary sacrificing 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. up to the annual cap) are no better off taking a TTR. Although their super account is now tax-free, they don't benefit from being able to make further deductible contributions and are required to withdraw from their super account and pay a high rate of marginal tax on it (even allowing for the tax offset).

However it depends on your personal circumstances. If you’ve got a large super balance, a large tax-free component (for instance, from making non-concessional contributionsVoluntary contributions made to your super account out of after-tax income (savings). Non-concessional contributions are not tax deductible and can't be salary packaged. See the ATO website for more information.), or a high level of income in your fund (for instance, you’ve realised a 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.), the story might be different.

If you’re not comfortable doing the necessary calculations yourself, we recommend seeking personal advice. This is one of those points in the superannuation cycle where seeking one-off strategic, personal advice has the potential to save you a lot of money.

Once you’ve decided to take a TTR, the next question is how you do you go about it?

Consult your trust deed

The first step is to read your SMSF’s trust deed and see what it says about pensions, since the trustees must comply with it. Ideally it will say very little, giving you maximum flexibility to pay pensions as the trustees see fit. But it should give a fund with individual trustees the power to pay a lump sum benefit – assuming you might want to pay a lump sum one day – otherwise the SIS ActThe Superannuation Industry (Supervision) Act 1993. It is the main piece of law governing the operation of superannuation funds (including SMSFs). won’t allow it.

If you’ve got one that’s problematic, has ‘whacky wording’ or you’re just not sure, consider updating it, especially as it will make the other steps easier. Members will soon be able to purchase our trust deed (check here for updates), but you can also choose from one of the various online document providers (for example Topdocs, Reckon and Cleardocs).

Whether you use our deed or not, we generally recommend getting your pension kit from the same provider. That way you’ve got the peace of mind that they’ve been designed to work in concert.

Application form

The next step is to apply for the pension. For SMSFs, this involves you (as member) handing yourself a letter (as trustee) that says you’ve reached 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. and you’d like to commence a pension. You also indicate the date the pension is to start, what percentage you require and the frequency (for example, monthly).

If you wish, you can start a pension on 1 July and not take a payment until as late as the following June (which helps in the year you turn 60, as pension payments become tax free from your birthday onwards).

If you’re nominating a reversionary beneficiaryThe person nominated to continue receiving a member's super pension after their death. A reversionary beneficiary must be a 'pension dependant', which means a spouse, a child under 18 (or 18-25 and financially dependant), a person living in an 'inter-dependency relationship' with the deceased, or a person who is financially dependant on the deceased. you should include them in the application.

Trustee documentation

At this point, the trustee(s) takes over. Once the pension has been requested, the following steps need to take place:

  1. Product Disclosure Statement (PDS). The trustee needs to provide the member with a PDS. The PDS essentially describes how super pensions work (in tune with your Trust Deed).
  2. Pension Agreement. The trustee should also provide the member with a draft pension agreement, which sets out the mechanics of how a pension works under the legislation.
  3. Trustee Resolution. The trustee(s) then passes (signs) a written resolution setting out the pension terms and resolving to enter into the pension agreement, set up and pay the new pension account, register for PAYG withholding (if necessary) and obtain actuarial certificates (if one is needed).

We typically recommend to personal advice clients that they do this on 1 July where possible. Since accounts are prepared (and assets valued at market value) at 30 June, it’s easy to establish the member’s account value and there’s no need to worry about what’s happened in the interim.

But this isn’t a requirement. If you’re establishing a pension mid-year, the Tax Office will generally accept working from the prior 30 June accounts with appropriate adjustments to the values of liquid assets (such as shares and managed funds). Alternatively, you can prepare interim accounts.

Assuming you take the 1 July approach, you won’t have the accounts when you pass the trustee resolution and prepare the documents. The trustee can deal with this by stating (in the pension terms) that the exact pension account value and tax-free component will be determined once the accounts are available. Once the accounts are final, the trustees then pass another resolution to settle the numbers.

How do you get the documents? The best way is by purchasing a ‘pension kit’ from the same provider you got your fund’s trust deed from.

The cost will range from between $300 to $600, the main variable being whether there is a review by a human being or the process is entirely automated. We prefer the extra layer of review because it minimises the risk of mistakes, but this is very much a personal decision.

Paying the pension

You can start paying your pension immediately based on an estimate of the account value, but you’ll need to make sure you ‘square up’ once the accounts are finalised and the exact account value known. The minimum pension that needs to be taken each year is based on the final account value, not your estimate.

You can time your pension payments with whatever best suits for personal requirements (for instance, weekly, monthly, quarterly or more). But to satisfy the minimums, you’ll need to take at least one payment annually and we recommend making at least two payments a year so there’s no doubt it’s a super income stream (quirky technical issues come up from time to time on this point).

Pension payments will come from the existing SMSF bank account, if the fund’s assets aren’t segregated (allocated to either the pension or accumulation accounts). If the fund is to be segregated, we recommend having two separate bank accounts, with one designated as the ‘pension account’. In this case, pension payments will come from here.

Investment Strategy

The shift to pension mode means you may need to reassess your fund’s investment strategy (and probably update your investment strategy document).

You’ll need to consider whether to focus on more income-oriented investments and also address the fund’s liquidityAn asset is ‘liquid’ when it can be easily converted to cash. Bank deposits, short term bonds and large listed shares are very liquid. Investments such as property and art aren’t. An investor is also said to be ‘liquid’ when they have plenty of cash and other liquid assets in their portfolio or spare borrowing capacity which allows them to make investments at short notice. Liquidity is a reference to how liquid an asset (or investor) is. needs, given the need to make pension payments.

See below for an example liquidityAn asset is ‘liquid’ when it can be easily converted to cash. Bank deposits, short term bonds and large listed shares are very liquid. Investments such as property and art aren’t. An investor is also said to be ‘liquid’ when they have plenty of cash and other liquid assets in their portfolio or spare borrowing capacity which allows them to make investments at short notice. Liquidity is a reference to how liquid an asset (or investor) is. clause based on our template investment strategy document (coming soon):

[Clause Number] Statement on liquidityAn asset is ‘liquid’ when it can be easily converted to cash. Bank deposits, short term bonds and large listed shares are very liquid. Investments such as property and art aren’t. An investor is also said to be ‘liquid’ when they have plenty of cash and other liquid assets in their portfolio or spare borrowing capacity which allows them to make investments at short notice. Liquidity is a reference to how liquid an asset (or investor) is.

Anticipated benefit payment:

1 year                          $[amount]

2 year                          $[amount]

3 year                          $[amount]

4 year                          $[amount]

5 year                          $[amount]

Pension payments are made annually. The trustee will monitor the liquidityAn asset is ‘liquid’ when it can be easily converted to cash. Bank deposits, short term bonds and large listed shares are very liquid. Investments such as property and art aren’t. An investor is also said to be ‘liquid’ when they have plenty of cash and other liquid assets in their portfolio or spare borrowing capacity which allows them to make investments at short notice. Liquidity is a reference to how liquid an asset (or investor) is. position of the Fund to ensure that there will be sufficient liquid assets to meet the benefit payments as and when they fall due.

Essentially, as a trustee, you’re aiming to show that you understand your pension payment obligations and are investing to meet them.

Final comments

It’s easy to get blasé about the paperwork, but don’t. We've had experience picking up the pieces when accountants have left it until after the financial accounts are completed to ‘fill in the paperwork’. Interim events – for instance, the death or incapacity of a member – can you leave you with a mess (including not having a valid pension).

Given the cost involved in buying a kit (especially relative to the damage mistakes can inflict), we don’t recommend trying to do this completely on your own. If you’re reviewing the appropriateness of your current trust deed, be sure you know what you’re doing and seek personal advice if you’re unsure.

 

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). Ben Smythe is a principal of Smythe Financial Management Pty Ltd (www.smythefm.com.au), a corporate authorised representative of Financial Professional Partners Pty Ltd (AFSL 466050). 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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