Tens of thousands of Australians will be rethinking plans to “ease into retirement” as new super rules, announced as part of the 2016 Budget, reduce the advantage of popular transition pensions.
"Concessional cap cuts and tax on earnings severely squeeze transition to retirement pensions."
Transition to retirement (TTR) pensions were introduced in July 2005 to help Australians who wanted to ease into retirement via part-time work.
Mercer financial adviser Andrew George says the most popular transition strategy has been to put as much before-tax pay as possible into super and replace that income with tax-free pension payments. Australians over 50 have been putting up to $35,000 a year (the current concessional contributions cap) into super this way.
George says investors with TTR strategies in place will now need to weigh up their ongoing value due to two major rule changes set to take affect from 1 July, the loss of tax-free earnings and reduced concessional contribution caps.
While the tax on the income you draw from your TTR will stay the same (tax-free if you’re over 60 or your marginal tax rate less 15% if you’re under 60) earnings will be taxed at 15%, just like a normal super account.
Meanwhile the amount of salary you can pay into super before tax has been reduced, with concessional caps cut from $35,000 for those over age 50 to $25,000.
“The tax-free earnings were essentially a ‘free kick’ and could add 1% or more growth to your savings each year – that’s gone now,” George says. “At the same time, a $10,000 cut to concessional caps means your ability to maximise before-tax contributions has been severely squeezed.
“From a purely tax point of view, the case for a transition to retirement strategy is not as compelling. There could still be additional tax advantages for some investors, but it’s not straight forward; anyone with a TTR in place should be reviewing it and weighing their options.”
Those options include rolling the money back into super or retiring and converting your TTR to a full pension. A full pension retains the 0% tax on earnings, previously available to TTR accounts. Anyone who can access a full pension can use this to retain the tax advantages being removed from TTRs.
THE STRATEGY STILL WORKS FOR SOME
George says, regardless of the 1 July changes, a TTR still gives you access to your super while you are working and you can still take advantage of super’s concessional tax rate – especially if you’re over 60.
“If you’re over 60 the income you get from a TTR is still tax-free and if you’re not using all of your concessional contribution cap then it may still be viable,” he says. “In that case, it still makes good sense to pump as much before-tax salary into your super as possible and draw it back as a tax-free income from your transition pension.”
George says investors will now be more likely to start a TTR pension to reduce debt or to achieve a target level of income – to fund living expenses while working part-time, for example. And if you’ve already started a TTR for either of those reasons, then it might still be the right for you.
“A lot of people currently use a TTR strategy as a way of accessing super because they need the cash, and that won’t change,” he says. “In fact, after 1 July the strategy becomes largely about cash flow.”
The message from the government, George says, is to start thinking about super earlier in your career.
“10 years ago concessional caps were $112,000 so you could really smash your super in the last few years of your working life,” he says. “You can’t do that anymore, so you should be aiming to max out your $25,000 caps each year, starting by the time you’re 50.”
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