Transition to retirement pensions (TTRs) were introduced in 2006, in tandem with the Howard-Costello reform of the superannuation system. Australia was facing a growing skill shortage, with the oldest Baby Boomers celebrating their 60th birthdays – and as more and more of them retired, the difficulty of finding replacements was growing.
At the same time, many older workers wanted to cut down on their hours and were happy to accept a reduced wage for doing so, but they did not want to give up work completely. Their problem was access to super. Even though withdrawals from super became tax free from age 60, employees could not access their super until preservation age (55 if born before July 1, 1960) unless they were prepared to sign a statement that they were permanently retired. And once they reached 60 they had to resign from a job to access their super.
TTRs solved the problem, enabling the 55-and-overs to have their cake and eat it too. Australians could access their superannuation as an income stream while continuing to work.
If they were aged between 55 and 60 the income from the TTR was fully taxable, less a 15 per cent rebate – if they were 60 or over, it was tax-free. The cream on the cake was that their superannuation fund became a tax-free fund once the income stream started. Obviously a tax-free fund has higher after-tax returns than one that pays 15 per cent tax.
What made TTRs particularly attractive was the ability to continue contributing to super while drawing a tax-free income from the fund; it enabled anyone adopting the strategy to take advantage of the difference between the 15 per cent tax on contributions and their marginal tax rate.
The regulations regarding TTRs have been tightened from July 1, 2017. The income stream from the TTR will remain exempt for those aged 60 and over, but the fund will pay 15 per cent tax on its earnings instead of being tax exempt.
The good news is that a TTR still gives you access to your super while you are working, and also enables you to take advantage of the difference between the 15 per cent tax on contributions to super and your marginal rate.
Think about a person aged 60 who is on $100,000 a year, receiving $9500 a year in employer superannuation, and who has $300,000 in super. Under the rules that come into force on July 1, when the concessional cap reduces to $25,000 a year, they will still be able to contribute an extra $15,500 a year to superannuation using salary sacrifice. The contributions tax would be $2325, which is much less than the tax of $5850 they would incur if the money was taken in hand.
However, they may not be able to maintain their lifestyle if their salary is reduced by a net $9455 a year ($15,500 less income tax of $6045). This is where the TTR becomes a handy tool, because it enables them to start a pension from their super fund to make up any shortfall in the household expenditure.
They could simply start a TTR for $12,000 a year – the minimum required – use $9455 to make up their cash shortfall and re-contribute $2545 to their super as a non-concessional contribution on which no contributions tax is payable.
Look at the outcome. They have maintained their net take-home pay, and have added $3720 to their super ($15,500 voluntary contribution minus $2325 contributions tax minus $12,000 TTR plus $2545 after-tax contribution). It's money for nothing.
Even though I strongly believe that your superannuation should be preserved until you retire, a TTR does offer a lifeline for people who are strapped for cash. Think about a person aged 60 with $400,000 in super who wants to continue working but has problems making their mortgage payments because they had a financial calamity, or because one of their children needs urgent assistance.
They cannot access their super until they retire, or turn 65. However, they could start a TTR of 10 per cent of the superannuation balance, which is the maximum allowed. This would provide the family with a tax-advantaged income of $40,000 in the first year and go a long way to solving their financial problems. When the crisis is over, they could stop the TTR, or use the strategies above to increase their contributions without reducing their take-home pay.
Despite the continuing tightening of superannuation concessions there are still some great strategies available for those who take good advice. Make sure you are one of those people who make the effort to do so.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: noel@noelwhittaker.com.au