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Self Managed Super Fund (SMSF) Article
Are Transition to Retirement Pensions Worthwhile?
By Tony Negline.
This article may be out of date.
18th November 2009
Since July 2004 older Australians have been able to make use of Transition to Retirement pensions or annuities.
They have been very popular for those approaching retirement but may have lost a lot of their usefulness because of changes made in the 2009 Rudd Federal Budget.
Transition to Retriement pensions are sometimes called TtR pensions, TRAPs ("Transition to Retirement Allocated Pensions") or TRIS' ("Transition to Retirement Income Streams").
The idea behind these income stream products is simply to encourage older workers to remain in the workforce for longer. As a government document published when the TtR policy was first announced said, this policy will give investors "more flexibility in developing strategies in their transition to retirement. For example, a person might choose to continue to work with their employer on a part time basis, and use part of their superannuation to supplement their income instead of leaving the workforce altogether".
Under normal super rules, investors aged under 65 have to be permanently retired before being allowed to access their super benefits. The technical jargon often used in these situations is that super money must be "preserved" (that is, held) in the system until a "condition of release", such as retirement, is satisfied.
The Transition to Retirement rules allow an investor to ignore these preservation rules and to access their super benefit as a TtR pension as long as the person is aged at least 55 and not fully retired. Lump sum withdrawals are not allowed from these TtR pensions until a person is aged at least 65 or permanently retired.
As it turned out when the government implemented these rules they allowed someone to begin a TtR pension even if they were working full-time.
The Costello Better Super changes which began in 1 July 2007 made TtR pensions particularly attractive especially for those aged at least 60 because all pension income is paid tax-free. But how do the numbers actually work?
This question is best answered by an example.
Bill Smith is 61 and wants to work full-time for another between five and 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 2009/10 tax rates, Bill would be paying $33,850 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 $86,000.
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 salary sacrifice super contributions and to convert his super assets to a TtR pension and to take his income requirements tax-free.
On the face of it this is a sensible idea. Salary sacrifice contributions tend to provide tax savings and he would meet his income needs via the pension tax free.
The salary sacrifice contributions are really employer contributions and the super fund must deduct tax in the year they are made.
Because of changes made in the 2009 Federal Budget the first $50,000 of employer contributions for people over 50 will be taxed until at 15% each year until 30 June 2012. Contributions above this threshold will be taxed at the highest marginal rate, that is, 46.5%.
On $120,000 of salary sacrifice contributions Bill would pay $40,050 tax. Without much thought Bill has managed to pay $6,200 in additional tax compared to taking all his salary package as take-home pay.
Before this budget announcement, the first $100,000 of super was taxed at 15% and the balance at 46.5%. This means that if Bill had salary sacrificed his total salary package he would have paid contribution tax of $24,300 – a saving of $9,500 of tax compared to taking all of the $120,000 as salary.
In reality Bill's most tax efficient option before the 2009 Federal Budget night would have been to take $20,000 as salary and salary sacrifice $100,000 into super. Bill would pay $15,000 tax in super fund contributions tax and $750 tax on his income. A total tax cost of $15,750 versus $33,850. No wonder Bill wanted to work for a few years longer.Based on my analysis, at no point is Jim better off after the 2009 Federal Budget taking a TtR pension. It should come as no surprise if people like Jim decide retirement is their best option. What financial incentives are there to keep working?
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