Transition-to-retirement income streams (TRIS) being paid from a self managed superannuation fund (SMSF) are a vital part of the membership cycle and can play a vital role in the estate planning process. There are also other taxation benefits that can be achieved via their use.
Let’s talk about salary sacrifice tax deferral
A member who has attained preservation age but is under 60, will still in many instances benefit from a salary sacrifice and transition-to-retirement strategy.
Here’s an example
Simon (58 prior to 1 July 2021) earns $100,000. Simon’s employer is required to pay 10% Superannuation Guarantee on his income so he currently has contributions made totalling $10,000. Without salary sacrifice, or contemplating other tax offsets, Simon will pay $24,967 tax (incl Medicare) and have a take home pay of $75,033.
If Simon sacrifices $17,500 to his SMSF, his personal tax liability will be $19,280 with a net take home of $63,220. It is correct to identify that Simon will pay an additional $2,625 tax within the fund on the contribution but this tax is not paid until the fund lodges its annual return, so there is a deferral of tax.
If we assume that Simon has $550,000 in his SMSF (based roughly on the average balance for 55-59 year old from recent ATO statistics), it means he can draw between $11,000 and $55,000 as an income stream. Simon doesn’t need that much so only puts $300,000 in to a TRIS. This gives him the capacity to draw $12,000. The reason he selects $12,000 is that by withdrawing $1,000 per month from the SMSF and not claiming the tax-free threshold, Simon’s SMSF will withhold approximately $70 PAYG per month (after taking into consideration the 15% tax offset) resulting in an annual after-tax income of approximately $11,000 meaning he’s not only playing less tax but he is receiving similar net income. This includes the tax the fund will pay on the additional contribution. Even if you factor in the earnings the fund has to pay tax on, they are negligible when the capital increase is $17,500.
The net position is that Simon’s super balance grows, his income remains stable and he pays less tax. This assumes 100% taxable component.
Attaining Age 60
The salary sacrifice element to the strategy will continue to be a benefit for most from age 60.
Non-assessable non-exempt income for withdrawals from super from age 60 mean that for most, even the smallest contribution and TRIS strategy will benefit as they will reduce their overall marginal tax rate.
If you consider Simon’s example above, then at age 60 he can draw the additional monthly amount but without the additional PAYG obligation further increasing his balance in super and reducing his tax.
Estate planning
Whilst there are overall tax savings to be made via the use of a TRIS, the greatest benefit they serve may still be the estate planning flexibility.
To understand why, it’s important to understand how certain elements of super work.
Separate interests within an SMSF
Members of an SMSF only have one superannuation interest until such time as they commence an income stream. Each income stream commenced gives rise to a new superannuation interest and these interests remain separate up to and including the payment of a death benefit.
Individuals may therefore choose to maintain multiple SMSF pensions for tax and estate planning purposes and this can commence from preservation age.
Commencing an income stream
Unlike lump sums from an accumulation interest, income stream interests only have their tax free and taxable components calculated at commencement. In an income stream interest all growth, and losses, are proportional based on these component percentages determined at commencement.
TRIS interests
Since 1 July 2017 a TRIS is considered to be in the accumulation phase and subject to taxation at the fund level. A TRIS will be considered to be in retirement phase from the member’s 65th birthday or at such time that the member satisfies one of the following conditions of release and notifies the Trustees of their fund that the condition has been met:
- Retirement
- Permanent Incapacity
- Terminal illness.
The movement from accumulation phase to retirement phase is prospective so will not occur until the member notification is received by the trustee, which in the instance of an SMSF should be instantaneous!
Now it is important to understand that a separate interest is still created when a TRIS is commenced, however, that interest may be taxed in the accumulation environment until it meets certain conditions.
Once you understand this then you will see that a TRIS can still provide some strategic advantages to members that have attained preservation age, as existing benefits can be isolated from future contributions, meaning estate planning strategies that previously relied on multiple income streams can still be commenced during the transition to retirement stage of an individual’s life.
Starting the estate planning process
Understanding the concept of single versus multiple interests and proportioning can provide significant benefits for estate planning purposes. Lump Sum death benefits are not assessable when paid to a tax dependent such as a spouse or a child under the age of 18, however, the taxable component will be taxed at 15% (plus Medicare) when paid to a non-tax dependent such as an adult child.
By establishing more than one income stream interest within an SMSF a member may be able to distribute benefits upon their death in a more tax effective manner.
Further, they can start earlier making determinations about what money (and potentially what assets) can be maintained within the super environment particularly as they have the ability to pay a reversionary pension to their spouse.
Transfer Balance Cap
One thing to consider is the transfer balance cap. As there is no restriction on the balance required to commence a TRIS in accumulation it is not important to consider the cap, currently $1.7m at the outset. However, when the member satisfies a trigger point to move to retirement phase it is necessary to ensure the TRIS balance does not exceed the transfer balance cap. This may require a partial commutation to return some benefits to accumulation.
As can be seen via the outlined opportunities, a TRIS is one of the most versatile strategies available in the SMSF sector. The taxation calculations within the article are for illustration only and don’t contemplate all tax scenarios. Anyone considering a TRIS should seek appropriate advice.
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 regard to your circumstances.