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Self Managed Super Fund (SMSF) Article
Transition to Retirement

By Tony Negline.

This article may be out of date.

9th August 2006

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Transition to Retirement is the Howard Government’s best superannuation policy.

The official purpose of the policy is to encourage older Australians to work for longer by encouraging them to work part-time and supplement their income needs by using some of their super savings to pay them an income.

The reason this is the government’s best policy is not because the policy’s purpose is the best super idea our lawmakers have had over the last 10 years.  The facts are that the policy is relatively simple (well as simple as super laws can be!), is very flexible and delivers a wide range of benefits that the government probably never intended to provide.

Fortunately the government did not remove the Transition to Retirement (TtR) policy as part of its Federal Budget super changes.  In fact TtR is more attractive especially for those retirees who are least 60 and intend to work for a few years because assuming the super changes are implemented as announced from July 2007, super pension payments will be tax-free and assets backing the pension will also be taxed at 0%.

Lets look at some examples to understand how this might work.  Bill Smith is 61 and wants to work full-time for another 5 – 10 years.  He earns $120,000 per annum.  He and his wife own their home and have one adult child still at home.  They need $50,000 a year after tax to live on.  Based on the new tax rates, Bill would be paying $35,850 in tax on his income (assuming he has no income or access to tax deductions or offsets).  Effectively his after-tax income is just over $84,000.  Bill also has $700,000 in super assets.  Bill’s employer will allow him to salary sacrifice as much of his salary as he wants.

He decides to take all his salary as super contributions and to convert his super assets to a pension and to take his income requirements tax-free.

On the face of it this is a sensible idea.  Under the government’s super proposal the first $100,000 of employer contributions for people over 50 will be taxed at 15% for five years beginning in July 2007.  Contributions above that will be taxed at the highest marginal rate, that is, 46.5%.  Effectively Bill would pay $24,300 tax.  Without much thought Bill has managed to save $11,500 tax and will have a much healthier super balance when he permanently stops work and retires.

But is this the best he can do?  Suppose that he salary sacrifices $100,000 and takes $20,000 as salary and reduces the pension being paid from his super assets to $31,500 per annum.  He will pay a total of $16,500 in tax ($15,000 contributions tax and $1,500 income tax).  His family will still receive $50,000 income and he has now cut his tax bill by more than 50%.

All the additional super benefits created by the salary sacrifice contributions will be taken out tax-free.  By any stretch of the imagination these are amazing results which are almost too good to be believed.

What happens when the five year transitional period has finished?  The first $50,000 of employer contributions will be taxed at 15% and the balance will taxed at 46.5%.

This means that if Bill sacrificed all his salary he would pay $40,050 in tax.  This is not worth it because this is more tax than if he took all salary and no super.

If he took $20,000 as salary then he would pay $32,000 in tax.  Again this is hardly worth it because it is only a small tax saving compared to all salary and no super.

What about people who are under 60?  People who are born before July 1960 who are at least 55 will be allowed to take their super savings as a pension whilst they are still working.  However their pension will not be tax-free but they will receive a 15% rebate.  This means that the Transition to Retirement strategy will not save as much tax as Bill Smith has been able to do.

For example suppose a person who is 58 has exactly the same circumstances as Bill Smith above.  That is, they took $100,000 of employer contributions and $20,000 as salary and $30,000 as pension income.  This would result in $20,850 in tax including the tax on the super contributions.  This is still a very impressive result and is definitely worth exploring further.

So what do we need to do to implement this in a Self-Managed Super Fund?  Make sure that your fund’s trust deed provides the ability to pay a pension before a member is retired.  Also make sure that your salary sacrifice agreement is implemented correctly.  Sometimes employment agreements will limit the amount that you can contribute to super.  Also some employment agreements will not include salary sacrifice super contributions in holiday or long service leave pay.  Some exclude salary sacrifice super in redundancy benefits.

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