SUPER CHANGES

19 June 2017

IS TTR STILL WORTHWHILE?

By Patrick Malcolm

TtR pensions will be impacted by the super reforms from 1 July 2017. Is a TtR pension still beneficial?

Income generated from assets supporting Transition to Retirement (TtR) pensions will be taxed as ordinary income of a super fund from 1 July 2017. Before this date, income earned from assets supporting a TtR pension is exempt from tax. Other super reforms taking effect on 1 July 2017 may also reduce the maximum benefit that can be derived from a TtR strategy.

For the purpose of this article, when we use the term ‘transition to retirement’ strategy, we are referring to the scenario where concessional contributions (CCs) are made into super, a TtR pension is commenced and the pension payments are used to replace the income contributed to super. Unless stated otherwise, we are not referring to the scenario where the pension income is used exclusively to replace lost income when scaling back working hours.

Impacts and opportunities

The main changes that may reduce or limit benefits of a TtR strategy are the:

• Removal of the tax exemption for fund earnings in pension phase (known as the ‘Exempt Current Pension Income’ exemption (ECPI)), when the pension is by definition, a ‘Transition to Retirement’ income stream, and
• Reduction in the CC cap to $25,000 for all taxpayers from 1 July 2017, which will limit additional salary sacrifice and personal deductible contributions that can be made to maximise the personal income tax benefits available from the strategy

The benefits of a TtR strategy may be improved by the:

• Introduction of the ‘catch up’ CC regime from 1 July 2018, and
• Broadening of the ability to claim tax deductions for personal contributions to include those who have more than 10% of their income from employment activities.

Personal taxation benefits

From 1 July 2017, the benefit from a TtR strategy will be limited to those derived from personal tax savings. The tables below illustrate the personal tax benefit for individuals on three different marginal tax rates, per $1,000 of salary. Specifically, they show:

• The net salary received if not salary sacrificed
• The net contribution to super, if salary sacrificed (taking into account 15% contributions tax and ignoring any potential liability for Division 293 tax, an additional 15% tax on concessional contributions for those earning more than $250,000)
• The dollar value of the pension payment that would need to be drawn to replace the net salary that would have otherwise been received, and
• The net benefit of the strategy, per $1,000 salary sacrificed.

Because TtR pension payments paid to someone over the age of 60 are not taxed, a larger personal tax benefit is derived from the strategy for people aged at least 60, compared to those under 60.

Individuals aged preservation age to 59 – Benefit per $1,000 salary received vs TtR strategy between preservation age and 59

The results shown above can be used to assess the personal tax benefit in different scenarios.

For example, when $15,000 of income within the 39% tax bracket is salary sacrificed into super and the income required to match cash flows is drawn from a TtR pension, the personal tax benefit is 15 x $47, which is $705 p.a.

Individuals aged at least 60

The net benefit of a TtR strategy increases for a person aged at least 60 as the income payment is not subject to tax at the individual level.

The taxation of each individual pension payment is based on the person’s age at the time the payment is made. However, in the table below, we have assumed that the person is aged at least 60 for the entire financial year for simplicity, and to show the net annual benefit.

Individuals aged at least 60 – Benefit per $1,000 salary received vs TtR strategy aged at least 60

Leveraging the results above, the personal tax benefit to be derived by a person over age 60 when salary sacrificing $15,000 p.a. in the 39% tax bracket, (for example), would be 15 x $240, which is $3,600 p.a.

Impact of reduced CC cap

The lower CC cap of $25,000 will limit the maximum financial benefit for those who could otherwise have made greater levels of concessional contributions.

Case Studies

Salary sacrifice, TtR and lowering of the CC cap

Steve is 57. His quarterly salary is equal to the maximum contributions base for each quarter of the 2016/17 financial year. This means that Steve’s annual salary is around $206,480pa.

Steve’s employer pays 9.5% SG on his full salary. This equates to $19,615 p.a. This means that the maximum amount Steve can salary sacrifice without breaching his current CC cap of $35,000 is $15,385 and the net annual personal tax benefit of a TtR strategy is approximately $1,092 p.a.

When the CC cap is reduced to $25,000, the maximum additional salary sacrifice contributions he can make will be $5,385, limiting the net benefit attainable to approximately $382 p.a.

If, on the other hand, Steve was 60, the maximum annual benefit available would be:

• $4,923 p.a. with the CC cap at $35,000, or
• $1,723 with the CC cap reduced to $25,000.

Income – 34.5% MTR

Lauren is 57 and earns $80,000 in salary. Her employer pays 9.5% SG on her salary, which is equal to $7,600 p.a.

In the 2016/17 year, her CC cap is $35,000. In addition to her SG, she is able to contribute an additional $27,400 in CCs via a salary sacrifice arrangement, totalling $35,000. This means that the maximum annual benefit from a personal tax perspective of this strategy would be roughly $986.

When the CC cap is lowered to $25,000 p.a. from 1 July 2017, Lauren will only be able to make additional CCs on top of her SG of $17,400 p.a. This means that the maximum annual benefit attainable will be reduced to $626.40 p.a.

However, if Lauren was 60, the maximum annual attainable benefit available would be:

• $5,343 p.a. with the CC cap at $35,000, or
• $3,393 p.a. with the CC cap reduced to $25,000.

Lower income earner

Peter is 58 and earns $50,000 in salary. His employer pays 9.5% SG on his salary, which is equal to $4,750 p.a.

In the 2016/17 year, his CC cap is $35,000. In addition to his SG, he is able to contribute an additional $30,250 in CCs via a salary sacrifice arrangement.

Therefore, the maximum benefit from a personal tax perspective of this strategy, assuming Peter salary sacrifices up to the annual CC cap, would be roughly $726.75 p.a.

When the CC cap is lowered to $25,000 from 1 July 2017, Peter will only be able to make additional CCs on top of his SG of $20,250 p.a. This means that the maximum benefit from a personal income tax perspective will be reduced to $576.75 p.a.

If, however, Peter was 60, the maximum personal taxation benefit available would be

• $3,656 p.a. with the CC cap at $35,000, or
• $3,006 p.a. with the CC cap reduced to $25,000.

Potentially beneficial changes

Two measures which could enhance the TtR strategy for some and to an extent offset the reduction in tax benefit from the strategy are the:

• ‘Carry forward CC’ regime, and
• Ability to claim a personal deduction for super contributions irrespective of the amount of employment income received.

Carry forward CCs

Eligible individuals with a total superannuation balance of less than $500,000 on 30 June of the prior financial year will be able to make CCs above the $25,000 annual cap, where they have not fully utilised their CC cap in previous financial years.

Unused amounts will be able to be carried forward on a five year rolling basis. The new regime will only apply to unused amounts accrued from 1 July 2018.

This means that the 2019/20 financial year will be the first year that a person could potentially ‘make use’ of an unused carried forward CC if the eligibility criteria is met. However, to the extent that the catch up contribution is made as a personal deductible contribution, this benefit will only arise where a person has sufficient taxable income in future years to utilise the strategy and is limited by the amount carried forward. A person who intends to increase their annual salary sacrifice to make use of any available carry-forward amount will need to make the relevant amendments to their agreement with their employer.

Personal deductible contributions

Currently a person who is in an employment arrangement may not be able to fully utilise their available CC cap. Examples include where:

• An employer is unwilling to facilitate a salary sacrifice arrangement
• Their employment renders them ineligible to make personal deductible contributions pre 1 July 2017 due to failing to meet the ‘maximum earnings as an employee’ test, and
• Personal income is uncertain, for example bonuses, and is received late in the tax year such that it is not possible to salary sacrifice a sufficient amount.

From 1 July 2017 individuals will be able to claim a tax deduction for personal contributions regardless of the amount of income received from employment. That is, the ‘maximum earnings’ test which currently requires less than 10% of total income be attributable to employment, is being abolished.

This change may provide some individuals who currently don’t have the ability to do so, the option to maximise their available CC cap by making personal deductible contributions.

Tips, traps and strategies

Check whether you have met a full condition of release

If you have previously commenced a TtR pension and there has been no need to consider the ability to access additional funds above the maximum 10% permitted annually, it may be the case that a full condition of release has subsequently been met.

Therefore, it is important that we are informed as to whether any changes to your employment have occurred which would effectively mean that a full condition of release has been met.

Example:

Warren was born on 1 February 1956. In 2013, he started a TtR pension at age 57. At that time, Warren was still working full time, so his TtR pension balance is ‘preserved’.

In March 2016, a month after celebrating his 60th birthday, Warren resigns from his existing job, after being offered a more preferable position elsewhere, earning a similar salary.

He doesn’t need any more or less from his existing TtR pension, so he doesn’t feel the need to contact his financial planner.

Even though Warren continues to work full time, he has ceased an employment arrangement after age 60, which is in itself, a full condition of release.

Even though Warren doesn’t need to vary his income payments from the pension, a full condition of release has been met and the funds in the pension are changed to unrestricted non-preserved. By definition, Warren’s pension is no longer a TtR pension.

Timing of payments

When payments from an income stream are received by someone over the age of 60, the tax free nature of the payment received increases the ‘pay off’ from the TtR strategy. Therefore, there may be a small planning advantage for those turning 60 during the financial year in relation to the timing of income payments.

As the taxation of income payments is dependent upon the recipients age at the time the payment is made, you may be able to ‘time’ a pension payment to fall after an individual’s 60th birthday during that financial year. The appropriateness of this strategy will partially depend on individual preferences and cash flow requirements.

When else might a TtR pension be appropriate?

Individuals reducing working hours

As mentioned earlier, the ability to start a non-commutable pension after reaching preservation age was originally introduced to enable individuals to ‘transition to retirement’ in the true sense of the phrase; that is, to reduce their working hours, while being able to access some of their super to supplement their income.

TtR pensions may still be appropriate for these individuals, regardless of these new changes. While the net tax benefit will reduce the tax ‘payoff’ from the strategy, for many, their lifestyle objectives will be their priority, and potentially the key motivation to accessing their super as a TtR pension.

Individuals <60 with a large tax-free component

The tax components of a pension are fixed at the commencement of the pension. This means that any subsequent earnings will be allocated proportionately to each of the tax components.

Individuals who have commenced a TtR pension with a relatively large tax free component, won’t escape having to pay fund internal tax on account earnings, but the effectiveness of a TtR strategy for these individuals might be preserved to an extent, due to a reduced personal tax liability on income payments.

This is because even though pension payments from the taxable (taxed) portion of the fund are income, the payments attributable to the tax free component are not subject to income tax.

This means that if the taxable component of each pension payment is relatively small, minimising the amount that is to be included in assessable income and taxed at the MTR (with a 15% offset), creating an additional tax efficiency.

Equalise super balances or pay off debt

The benefits of a TTR strategy may be increased where TtR income stream payments can be used to:

• Allow a spouse to make after tax contributions to equalise balances between the client and their spouse (e.g. to make best use of the transfer balance cap)
• Allow debt to be paid off (e.g. their mortgage).

TtR strategies for those who have reached age 60 that involve equalising or optimising balances between spouses may be used to assist with the following:

• Ensuring both spouses keep their superannuation balances within their transfer balance cap
• Keeping one spouse’s total super balance below $500,000 to allow them to carry forward unused concessional cap amounts in future years
• Keeping one spouse’s total superannuation balance below $1.6 million to allow them to make further non concessional contributions to their super in the future

Those aged 60 or over may benefit from undertaking a TtR strategy which provides tax-free pension payments that are used to repay a mortgage more quickly.

Summary:

The key messages to come from our analysis of the changes are:

1. The TtR strategy may still be worthwhile, but in more limited circumstances
2. The value derived will vary depending on your specific circumstances
3. For many people, particularly those under the age of 60, the net benefit from the strategy will be significantly lower under the new rules
4. The benefit of retaining existing TtR pensions as part of a TtR strategy may need to be reassessed
5. TtR pensions remain an effective vehicle to support those who wish to reduce their working hours

Patrick Malcolm
Partner
Certified Financial Planner®
SMSF Specialist Advisor™
Authorised Representative No. 278061

If you have any questions or comments, please email me at patrick@gfmwealth.com.au

Disclaimer: This document is not an offer or invitation to any person to buy or sell any interest in or deposit funds with any institution. The information here is of a generic nature, and does not take into account your investment objectives or financial needs. No person should act upon this information without firstly seeking competent, professional advice specifically relating to their own particular situation.

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