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 Transition to Retirement - Eureka Report Article 
 
 
 

Transition to retirement
By Scott Francis

PORTFOLIO POINT: Transition to retirement plans offer significant tax savings, including by drawing on super savings to increase super contributions.


For anyone still working over the age of 55 the new changes to superannuation are particularly lucrative. Although most media attention has focused on retirement strategies, it is the so-called "transition to retirement" plans that now offer one of the best tax-breaks yet seen in Australia.

Many investors are wary of tapping into their superannuation accounts too early but, as you'll see from the examples I quote later in this article, the new superannuation system creates some unlikely opportunities. You just have to know where to find the new tax breaks and design your income streams to fit the new system.

There are certain "must do's" that most people will need to follow to be successful in their personal financial journey. These include:
  • You must spend less than you earn.
  • You must, over time, invest in growth assets (such as shares and property).
  • You must make good use of superannuation, the lowest tax environment that we have in Australia
  • You must stick to your investment strategy. Don't constantly change asset classes and investment providers, both of which cost you fees and taxes. Set an asset allocation, choose your investments, and let the power of compounding investment returns work over time.
  • You must make sure that you do not pay too much in fees to the financial services industry (a Eureka Report subscription is great value; beyond that, tread warily).
  • You must avoid losing large amounts of money in sharetrading "programs", property scams or dishonestly promoted investment schemes such as Westpoint.

If, over a working lifetime, you spend slightly less than you earn, invest in growth assets, make good use of superannuation and avoid paying too much in fees, constantly switching investments or getting caught in scams then you will almost certainly be successful financially.

The proposed superannuation changes have provided another "wealth assisting" opportunity so powerful that the list of six items should now include a seventh:
  • You must use a transition-to-retirement income stream if you are working beyond the age of 60 to minimise the amount of tax you are paying. You must also investigate the effectiveness of this if you are working at age 55.

Let's have a look at how this powerful strategy works, with just a quick pause to mention that this is based on the proposed superannuation changes, which are yet to be passed into law, although it seems likely that they will.


Transition to retirement income stream

Transition to retirement income streams are a recent addition to the superannuation landscape. They allow a person who has reached their "preservation age" to access their superannuation benefits in the form of an income stream, even if they are still working. Your preservation age is as follows:

Date of birth
Preservation age
Born before July 1, 1960
55
July 1, 1960-June 30, 1961
56
July 1, 1961-June 30, 1962
57
July 1, 1962-June 30, 1963
58
July 1, 1963-June 30, 1964
59
After June 30, 1964
60

Under the proposed superannuation changes, transition to retirement income streams will still be able to be used. People will be able to choose to take an annual income between a minimum of 4% (for someone under age 65) and 10% of the balance of their superannuation fund.

When retirement to transition income streams were announced, they were hailed as a strategy to encourage people to continue working part-time while drawing a superannuation income stream. As the following analysis shows, a transition to retirement income stream might make a lot of sense if you are working full time as well.


Looking at the numbers

Let us consider the case of a 60 year old, earning $60,000. Let us assume that they have a superannuation accumulation of $300,000. They find that their after-tax income exactly meets their cost of living, meaning their cost of living is $45,750 ? being the $60,000 income less $14,250 of tax.

Overall they are paying three lots of tax:
  • They pay $14,250 of income tax and Medicare levy.
  • They pay 15% contributions tax on their 9% ($5400) employer contributions: $810.
  • They pay tax on the earnings of the superannuation fund. Let's assume that the fund had taxable earnings (interest, dividends, distributions, realised capital gains) equal to 5% of the value of the fund. This is taxed at 15%, meaning $2250 of tax is paid. The total tax being paid is $17,310.

Let's consider the situation where a transition to retirement income stream is used. The person can salary sacrifice $35,000 to superannuation. This will give them a taxable income of $25,000. The reason we choose to take a taxable income of $25,000 is that this is the top of the bracket at which tax and Medicare levy of 16.5% is paid. If income is salary sacrificed to superannuation tax is still payable at 15%, providing only a marginal tax benefit over the 16.5% income in their own name. The total income tax and Medicare levy paid on $25,000 of income is $3,225 - leaving $21,775 after tax income.

The 15% contributions tax paid on the $35,000 salary sacrifice contribution to superannuation and the $5400 9% employer contribution to superannuation will be $6060. The total after-tax contribution will be $34,340.

If the total balance in the $300,000 superannuation accumulation is used to fund a transition to retirement income stream, the earnings on this accumulation are tax free. A $23,975 tax-free transition to retirement income stream can be drawn from this balance and, combined with the $21,775, will meet the cost of living of $45,750. This transition to retirement income stream is completely tax-free.

You will notice that the maximum tax rate faced is now only 16.5%. The total tax being paid is $9285.

In both scenarios the only "building of wealth" taking place were the contributions to superannuation. In the first scenario the after-tax contribution to superannuation was $4590 (being just the 9% superannuation contribution). In the transition to retirement scenario the net after-tax contributions to superannuation (after tax contributions of $34,340 less income drawings of $23,975) are $10,365. The transition to retirement scenario also has the benefit that the $300,000 superannuation accumulation paying the income stream is now tax-free, saving an estimated $2250 of tax.


But wait, there's more .

A lucrative twist to the above tale is that the person now has a taxable income of only $25,000, which allows them to make a government co-contribution. Because their income is less than $28,000 they can make a personal superannuation contribution of $1000 and receive a government co-contribution of $1500.

If we call this government co-contribution a "negative tax" of $1500, the total tax paid in the transition to retirement scenario is now $7785.

The following graph compares the total tax paid under the scenario where the $60,000 is taken as income.




But aren't superannuation funds being used up?

When transition to retirement strategies are suggested, people often express that they are concerned about starting to draw on their superannuation balance. So is superannuation being consumed in this situation?

The answer is an emphatic no; in fact, entirely the opposite is happening. Even though some superannuation is being drawn ($23,975), this is being used to fund increased superannuation contributions of $34,340 after tax. The net contributions to superannuation have more than doubled in the transition to retirement scenario!


What about for people under the age of 60?

The benefits for people under the age of 60 are less significant. If there are parts of their superannuation balance that is made up of components that can be withdrawn tax-free, such as undeducted components, the transition to retirement income stream will still result in a tax saving.

Let us consider exactly the same scenario: a person, in this case a male, earning $60,000 - $45,750 after tax. They have a $300,000 superannuation account with $100,000 being made up of undeducted contributions.

In this case the person can generate an after tax income stream of $45,750 by taking $25,000 of their income as salary and drawing $27,950 as a transition to retirement income stream. Of this, $27,950, $3846 will be tax free (because of the undeducted contributions in the fund), and the remainder will include a 15% pension tax rebate to offset the total tax paid.

The person can use their remaining $35,000 of salary to salary sacrifice to superannuation, being $29,750.

The tax benefit in this situation is that $2250 is saved because the superannuation fund is tax-exempt. There is also $1770 of income tax saved because $3846 of the transition to retirement income stream is tax-exempt.

Another way to quantify the benefit of this strategy is that in the situation where $60,000 of income was being earned the after tax contributions to superannuation were $4590. In the situation where the transition to retirement income stream was being used, the after-tax contributions to superannuation were $34,340. Given that there were superannuation drawings of $27,950, net contributions were $6390, an extra $1800 of contributions.
 
Scott Francis' articles in the Eureka Report 

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