SCOTT FRANCIS – 29 JULY 2013
Summary: Transition to Retirement Pension streams (or TRIPs) enable an individual to keep working and simultaneously draw down income from their superannuation fund. By salary sacrificing income into their super fund, individuals can achieve substantial tax savings – especially once they have reached the age of 60.
Key take-out: Income earned in a super fund after the age of 60 is tax free, providing an added benefit for those with a transition to retirement pension. But for those under 60, a transition to retirement income stream that is made up of some ‘non-concessional’ contributions (from after-tax contributions) will still provide a tax-effective income stream.
The Transition to Retirement Pension income stream is, hands down, one of the most effective personal finance strategies that there is.
People over the age of 55 can save thousands of dollars of tax by implementing this strategy. Because the benefits of the strategy are tax savings – the returns from the strategy are risk free.
In recent years there have been subtle changes that impact on the way that this strategy is used – especially the reduced level of concessional contributions that can be made to superannuation. Despite these restrictions, I think that the strategy still stacks up well – for a reason that many people overlook. There are two tax savings that come from the strategy. The first is that income salary sacrificed into superannuation is taxed at a 15% tax rate, rather than the 34% tax rate (income tax and Medicare) that the average person’s income is taxed at. The second tax saving – and the sometimes understated benefit – is that when a superannuation fund starts paying a pension it is taxed at a 0% tax rate, rather than the usual 15% tax rate. This benefit can be approximately 1% of the fund’s balance a year – or $5,000 on a $500,000 superannuation fund.
A good way to look at the benefits and cash flows associated with this strategy is to consider a case study. Let’s consider Sam. She is:
- Aged 60.
- Has a $500,000 superannuation balance.
- Earns $80,000 a year ($63,453 after tax).
- Has living costs of $60,000 a year.
- Currently saves $3,453 a year plus her compulsory superannuation contributions.
She wants to know if her situation can be improved through the use of a ‘transition to retirement’ income stream strategy.
The basics of the strategy are that she will convert her $500,000 superannuation balance to a transition to retirement income stream. She will draw some income from this, and it will be tax free. Therefore she will need less of her salary ($80,000 a year) to pay her living costs, and she will salary sacrifice any of her income that she does not need to meet her living costs to superannuation.
Turning her superannuation fund into a transition to retirement pension fund is her first ‘tax win’. Her superannuation fund (or account if she is not using a self-managed super fund) becomes tax free – a benefit of about 1% a year. This is equal to $5,000 a year on a $500,000 balance – a significant sum of money! As a real life demonstration of this take Q Super, the Queensland Government Superannuation fund. Its balanced pension fund, which faces a 0% tax rate, has a three-year return of 9.25% per annum and its balanced super fund (15% tax rate) has a three-year return of 8.06% pa.
Let’s assume that from her superannuation fund she draws a transition to retirement income stream of $20,000 a year. This is tax free, and means that she only needs another $40,000 a year from her salary to meet her living costs of $60,000 a year.
We now need to work out how much she can salary sacrifice to superannuation. Her limit on superannuation contributions is $35,000 a year (being over the age of 60). Her employer contributions will be 9.25% (new increased compulsory contributions for this financial year) of her $80,000 income, or $7,400. She can salary sacrifice a further $27,600 to superannuation. After the 15% contributions tax this $27,600 becomes $23,460, $3,460 more than the $20,000 she withdrew from superannuation.
After her salary sacrifice she is left with $52,400. After income tax this is $43,823. Sam needs $40,000 of this to add to her $20,000 transition to retirement income stream to meet her $60,000 cost of living – leaving her $3,823 in savings.
Sam’s benefits from the strategy are:
- Her after-tax superannuation contributions (excluding her compulsory contributions which I have assumed are the same under both models) are increased by $3,460 (being the after-tax salary sacrifice contribution of $23,460 less the $20,000 she withdraws from superannuation).
- Her superannuation fund earnings increase by about 1% now the fund is in pension mode – a benefit of $5,000 on her $500,000 fund.
- Her savings outside of superannuation have also increased slightly from $3,453 a year to $3,823, an extra $370 a year.
This is a total benefit of $3,460 + 5,000 + 370 = $8,830 a year.
What if you are not yet aged 60
A certain amount of the strategy is enhanced by the fact that the withdrawals from superannuation for someone aged 60 are tax free. For those people under the age of 60, a transition to retirement income stream that is made up of some ‘non-concessional’ contributions (from after-tax contributions) will still provide a tax-effective income stream. You can make a ‘non-concessional’ contribution to superannuation of up to $150,000 in a year (or bring forward three years of contributions and make a $450,000 contribution) if you want to increase this in your superannuation fund prior to starting a transition to retirement income stream. A person under the age of 60 still receives what was the most valuable tax benefit for Sam in the example – her superannuation fund earnings become tax free, adding 1% to the return from her superannuation balance.
A transition to retirement income stream is a risk-free way of improving your financial position close to retirement. In thinking about the benefits of the strategy, many people focus on the tax saving from salary sacrificing to superannuation. The second tax saving, that comes from having your superannuation fund pay tax at the 0% pension fund rate, is also likely to be significant and worth keeping in mind as you evaluate the suitability of the strategy.
Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.