Preparing for your retirement – Part 2

SMSF technical expert and columnist for The Australian newspaper
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Last week I mentioned the first couple of steps to take in finalising one potential strategy that will deliver you with income and estate planning benefits in retirement (Preparing for your retirement – Part 1).

To better explain your options, we’re using a hypothetical example where you have $1.2 million in retirement benefits of which 99% is initially in the Taxable Component.

Just to recap, you’re aged 63 and your spouse is 62 and you’re currently using this money to provide you with a Transition to Retirement pension. You’ll be fully retired by 31 December this year and want to know the best way to structure these super benefits. Your spouse has little or no super, but you share $130,000 outside super, which you would like to contribute into superannuation.

Contributions

The next step in our overall strategy involves contributing the $130,000 into super in your name as a Non-Concessional Contribution. Ideally, this should be done this financial year on the assumption that you are have the ability to make this contribution without incurring excess contributions tax, that is, you’re not in a situation where you’ll break your $150,000 non-concessional contributions cap.

With this particular contribution, you should consider if your spouse should make this contribution and claim the Spouse Super Contribution Tax Offset described in Part 1 of this article. To access this offset, your spouse will need to be paying income tax, which means your spouse will need to have earned income or capital gains subject to tax.

This contribution should remain in the accumulation phase until the next couple of steps can be completed.

Reducing your Taxable Component

If your current pension can be commuted, then you should partially commute it by taking $450,000 out of the pension as a lump sum. Sometime later, you should consider contributing these proceeds into your super fund in order to reduce your Taxable Component. You’ll probably want to wait until the next financial year so that you don’t break your contributions caps, so you’ll want to make sure you can make the $130,000 contribution followed by the $450,000 contribution (using the three-year bring forward rule). Make sure to familiarise yourself with the contributions caps before using this strategy because breaking them would result in a tax disaster.

You must make the $450,000 contribution before the end of the financial year in which you turn 65 years of age. You can’t make a contribution of this size after age 65 without incurring excess contributions tax. The ability to make this contribution assumes that by making it you won’t be subject to excess contributions tax.

After this transaction your super assets will be represented as follows:

When you’re ready, both the $450,000 in your spouse’s name and the $580,000 in your name can be used to commence account-based pensions. Both these pensions will be 100% tax-free pensions, which means any benefits paid from them won’t incur tax. The $300,000 pension benefit will be almost a 100% Taxable Component, while the $580,000 will be a 100% Tax-free Component

Your desired retirement income is $52,000 a year, which means your super assets need to generate about a 4% return each year. This seems quite achievable based on current yields from many investments including the additional requirement to protect this income from inflation over the long-term.

One strategy you might want to consider is taking as much income as possible from the pension with the largest taxable component so that it runs down in value faster than your other pensions.

Your death benefits

Before you commence these pensions, you should give some consideration to making these pensions reversionary in the event of your death. Alternatively, you could consider using Binding Death Benefit Nominations. You can find out more in Which death benefit option is best?

Another benefit of the reduced taxable component is that you’ve reduced the amount of tax your children will pay on any benefit you leave them. Based on the current account balances, upon your death your adult children will face a $50,000 tax payment.  This is a potential $150,000 saving on what they would have otherwise faced on $1.2 million of super. If the taxable component pension is dissipated as soon as possible, then the tax saving might be even higher.

Another potentially useful outcome from implementing these transactions is that it puts some of your retirement assets into your spouse’s name. This isn’t important given how our tax system is structured today, but who’s to say the same system will apply for the next 20 to 30 years? This defensive strategy might prove to be very important.

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.

Also in the Switzer Super Report

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