Back in the early 2000s we had a problem in Australia. We had a thing called a ‘skills shortage’. Skilled people were leaving the workforce to retire, and there was nobody to replace them.
In response to this dilemma the government at the time came up with a rather neat idea.
What if superannuation (super) laws were changed to allow people to cut back their working hours and, at the same time, permit their access to accumulated super savings?
Up to that time you were required to have been already retired to be able to access any of your preserved super benefits.
So on 1 July 2005 the ‘transition to retirement’ scheme was born.
Transition to retirement (TTR) allows people who have reached their preservation age of 55, (which is progressively increasing to 60 for people born after 30 June 1960) to access their preserved super benefits in the form of an income stream (pension), but not as a lump sum.
The introduction of TTR was greeted with much enthusiasm from the Australian public, and it has become a popular pre-retirement strategy used by many Australians.
The technical details can be rather confusing, but let’s see how we go.
When a super fund is paying a pension to its members – the fund is exempt from paying tax on the earnings it derives from investing member’s funds. This tax exemption translates to a higher investment return for fund members.
Super fund members drawing a pension from their fund pay no tax on the income they receive if they are aged 60 or over. Between preservation age and 60 – tax is payable on the taxable portion of the income received by the member, but there is a corresponding tax rebate or offset of 15 per cent.
Back in the early days of TTR – it didn’t take too long for people to realise that to access an income stream under TTR rules there was no requirement to actually reduce your working hours. You could commence a TTR pension even if you are continuing to work full time.
So now a person who had reached their preservation age could start drawing a tax effective income from their super, and use it to supplement other income.
But, why stop there? Let’s explore another layer of complexity to TTR.
What if I have commenced receiving a TTR pension, but don’t really need the income that is being paid to me by my super fund?
Where a person is working they are able to request that their employer make additional employer contributions to super under a salary sacrifice arrangement. This means that part of our salary is foregone and contributed to our super on our behalf. However – there are limits that apply to the contribution amount.
But – what is the advantage of doing this?
Salary is included as part of our income for tax purposes, and is taxed at our marginal tax rate – which can be up to 49 per cent. However – contributions made to super by an employer are taxed at a rate of 15 per cent.
If I am aged 60 or over, and I’m drawing an income from my super, the fund pays no tax on the investment earnings and I pay no tax on the income I draw from my TTR pension.
On top of that – if I sacrifice part of my salary back into my super a tax rate of 15 per cent is applied instead of that income being taxed at the top marginal tax rate.
Sounds too good to be true – doesn’t it?
There were some concerns that, following this year’s Federal Budget, the government were going to trim back some of the generous concessions that arose from TTR.
And we were not surprised – they did!
Subject to legislation being passed the government intends to tax the income earned on the underlying investments made by super funds currently paying TTR pensions. So – instead of the investment earnings being exempt from tax in the hands of the super fund the income will be taxed at a rate of 15 per cent (with capital gains being taxed at 10 per cent). The changes are scheduled to come into effect from 1 July 2017.
So – is this the end of the line for TTR?
Absolutely not! TTR will continue to remain a viable strategy for many people; particularly those aged 60 and over.
As with any super strategy – there can be some traps. Readers who either have a TTR pension in place now, or are thinking of establishing one, should consider seeking appropriate advice before rushing in and making any changes.
As things stand now; we have an election to get out of the way first and then legislation needs to be introduced and passed by the new parliament.
1 An additional 15 per cent tax is levied on contributions where an individual’s adjusted taxable income exceeds $300,000 per annum.