Does ‘transition to retirement’ still work?

Here is a great article by Peter Kelly from the Prepare for Life Publication looking at whether a transition to retirement is still a viable strategy.

Many readers will be familiar with a popular superannuation strategy referred to as ‘transition to retirement’. However, with the superannuation reforms that were introduced from 1 July 2017, some are questioning whether a transition to retirement is still a viable strategy.

Background

Back in 2005, changes to superannuation legislation allowed people to access their superannuation benefits, even though they had not retired. This change was referred to as ‘transition to retirement’ or more affectionately, TTR. The idea behind TTR was to allow people to progressively reduce their working hours and start drawing down on their super to supplement their reduced wage. There were several conditions attached to the operation of TTR. These included:

1. Super benefits could only be drawn as pension or income stream payments.
2. Payments had to be between 4% and 10% of a person’s super account balance.
3. Lump sums cannot be drawn from a pension account, although the annual prescribed level of pension income could be taken as a single income payment.

The evolution of TTR

When the legislation supporting TTR was introduced, a notable omission was the requirement that a person had to reduce their working hours. Whether this was deliberate or accidental remains one of life’s mysteries, however, in over 10 years of TTR, the requirement to have reduced working hours remains absent.

When TTR was first introduced, it didn’t take long to realise that a unique tax planning opportunity had emerged.

Money paid in the form of salary or wages is included as assessable income and is taxed at the recipient’s marginal tax rate. This may be anywhere between 0% to 45%, plus the Medicare Levy. However, contributions made to a superannuation fund are generally taxed at a maximum rate of 15%.

Consequently, there are significant benefits to having salary contributed to superannuation (being taxed at 15%), rather than receiving it as income that is taxed at the marginal tax rate (up to 45%). Foregoing salary and having it paid to superannuation is referred to as ‘salary sacrifice’.

Income payments made from a superannuation fund are also favourably taxed, particularly for people aged 60 or older, where no tax is payable on pension payments.

To cap things off, where a super fund is paying benefits to members in the form of a pension or income stream, the super fund pays no tax on the investment income it derives from its investments. This translates to a higher investment return to the members of the super fund.

To recap, the taxation benefits of a TTR pension are:

• TTR pension income paid from the fund to the member is concessionally taxed, particularly where a member is aged 60 or older.
• Investment earnings of super funds paying pensions are tax-exempt to the super fund, thereby enhancing returns paid to members.
• Contributions made to super under a salary sacrifice arrangement are more favourably taxed than if the income was paid as a wage or salary.

As a result, TTR offered significant benefits to those able to access their super, even if they may not need the additional income.

When bringing all the pieces together, the most popular application of TTR involved a person sacrificing part of their salary to super, and then commencing a TTR pension to replace their reduced salary. In simple terms, by working the tax advantages offered by TTR and salary sacrificing, considerable additional superannuation savings – often tens of thousands of dollars – could be accumulated in super in the years leading up to eventual retirement.

What has changed?

In its 2016 Budget, the government announced several important changes that would impact on TTR arrangements. These apply from 1 July 2017.

The first change that has a bearing on the attractiveness of TTR is the reduction, from $35,000 to $25,000, in the maximum amount that can be contributed to superannuation as an employer or salary sacrificed ‘concessional’ contribution. These contributions were critical to maximising the tax advantage of TTR.

While the reduction in the concessional contribution cap has had a negative, detrimental effect on salary sacrificing and the TTR strategy, it is not ‘the end of the world’!

The other change that applies from 1 July 2017 is the removal of the tax exemption on investment earnings made by superannuation funds on those investments they hold that are supporting TTR pensions.

The two changes will have an impact on the appropriateness of TTR pensions going forward. However, this remains a viable strategy for the right person at the right place and time.

TTR pensions remain appropriate for several groups including:

1. Those looking to supplement their income due to reduced working hours, transition from full-time to part-time work, or because of permanent work becoming casual. Those who need to supplement their income will continue to be able to do so using TTR. But remember, this is only available to people who have reached their preservation age (currently 56, but progressively increasing to 60 for those born after 30 June 1961).In some circumstances, drawing an income from superannuation under a TTR arrangement may be appropriate when looking to make additional mortgage repayments or repay other debts in the lead up to full-time retirement. Remember, that if drawing an income under TTR rules, limits apply to the amount they may be paid on an annual basis.
2. If aged 60 or older, TTR still represents a viable strategy when coupled with salary sacrifice, albeit at lower levels than previously available.
3. People aged between their preservation and 60 may still benefit from TTR where they have a reasonable amount of their superannuation account held as a tax-free component.

Is TTR still a viable strategy?

Like so many questions involving superannuation, the answer is very much a case of ‘it depends’.

Considering the viability of TTR in a post-June 2017 world requires a close examination of personal financial circumstances and necessitates ‘doing the numbers’.

If you are already drawing a TTR pension, or are wondering if it is appropriate for you, you should consider speaking with a qualified financial planner and have them provide guidance that is in your best interests.