During our regular ‘Super Show’ on 2GB last Tuesday night at 9.00pm (if you are outside Sydney you can listen online [1]), Peter and I were blown away by the number of calls about the “transition to retirement” (TTR) pension.
Every time we say that taking a TTR is a “no brainer”, we get the same sort of reaction. When you turn 55, the only reasons I can think of to not take one is if your fund doesn’t allow it or if it is going to charge you some horrendous fee (this shouldn’t be a problem for any SMSF).
SMSFs that pay a TTR pension may also incur an additional cost of arranging an actuarial certificate – however, these can now be done for around $300 to $400 and are easy to organise.
With the higher caps in 2014/15, there are more reasons than ever to consider taking a TTR pension in conjunction with making salary sacrifice contributions into super – which is known as the “income swap” strategy. You don’t have to do it in conjunction with salary sacrifice – just taking the TTR will generate a lot of the benefit because the investment earnings on the assets supporting the pension will be taxed at 0%, rather than 15%.
So, if you’re aged between 55 and 65 and are still working, start taking a TTR. Here are the numbers to prove why you should do it.
The “income swap strategy”
This strategy involves taking a TTR pension from your super, and then putting money back into super via salary sacrifice. It’s an “income swap” or “cash neutral” because you are left with the same number of after tax dollars to cover your living and other costs.
Essentially, the strategy works because on commencing the pension, your existing super balance is transferred out of ‘accumulation’ mode into ‘pension’ mode. This is important because your fund doesn’t pay any tax on the investment earnings in pension mode. Meanwhile, the amount salary sacrificed into super is taxed at the lowest concessional rate available to super funds.
The pension income you receive substitutes for the cash salary forgone by salary sacrificing, and the re-contribution of the salary sacrifice amount back into your super fund compensates for the pension payment.
A worked example
Let’s look at an example where we assume that the member is 56 years old, earning a cash salary of $100,000 and their employer contributes $9,500 into their super account (the compulsory 9.50%).
The member elects to salary sacrifice the maximum amount into super – which is $25,500 (the concessional cap of $35,000, less the employer contribution of $9,500).
Further, we assume that their superannuation balance is $300,000 at the start of the year, and that the investment return on this is 7% per annum.
Let’s calculate the numbers and compare the difference between the default case where the strategy is not used (i.e. without the TTR), and then the case where the strategy is applied (with TTR).
With and without a TTR strategy
* Assumes 7% net earnings. For simplicity, assumes all contributions and pension payment are made at the end of the year.
Breaking it down
In both cases, the member has the same after tax income of $73,053. However, by using the Transition to Retirement income swap strategy, the member’s superannuation balance has grown by an additional $4,358 ($330,283 compared to $325,925 where there is no TTR). This is the impact over just one year – if the strategy is commenced at age 55, the total increase in the member’s account balance over 10 years would be in excess of $50,000.
Further, the strategy becomes even more tax effective at age 60 because the pension payment ceases to be taxable. Between ages 55 and 60, the pension is included in the member’s taxable income. Although a tax offset of 15% is available, most members will pay some tax during this period.
Some points to note
Firstly, there are rules that govern maximum and minimum TTR pension payments. On the maximum side, the pension can’t be more than 10% of the member’s start of year balance. The minimum pension payment is 4%, which on a super balance of $300,000 is $12,000. Also, once a TTR pension is commenced, it can’t be commuted (back to a lump sum cash withdrawal) unless a condition of release, such as permanent retirement, is met.
Most importantly, the other limitation to this strategy is the concessional contributions cap limit, which in 2014/15 for those aged 50 or more is $35,000. Tax at your marginal tax rate is payable on any excess contributions, so don’t go over it. The cap includes employer contributions, salary sacrifice contributions and for the self employed, contributions for which a tax deduction is claimed.
The TTR income swap strategy is one of the simplest ways to increase your superannuation account balance. And in case you are worried, the ATO has stated (admittedly in a press release only) that this strategy doesn’t breach the Part IV A general anti-avoidance rules.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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