Over 55? Is a transition to retirement pension the right strategy?
Transition to retirement pensions — the range
From 1 July 2005, it is easier for a person who has reached preservation age (currently, aged 55 or over) to draw on superannuation savings while still working. However, the person must take their benefits as a non-commutable pension. The pension can be any of:
- a lifetime "complying" pension,
- a market linked pension, or
- an allocated pension — in which case the person can not cash in the pension for a lump sum (known as "commuting") until they have satisfied a condition of release (typically, retired or reached age 65).
Beware the traps and pitfalls
The key traps and pitfalls are:
- Potential impact on future benefits This is particularly important if a defined pension is involved, where the benefits are related to age and length of service.
- Potential impact on insurance arrangements Existing life insurance cover may cease or reduce. Also, if new contribution arrangements are entered into, then sums insured may reduce, and medical examinations may be required which might lead to new conditions being imposed.
- Timing Consider the overall gain of withdrawing benefits between 55 and 60 — given that the Federal Budget proposals are likely to remove tax on benefits after age 60.
- Proposed limits to concessionally taxed superannuation contributions. Consider the tax-effectiveness of any associated re-contribution strategy (see below) in light of proposed new tax-effective contribution limits.
Strategies involving transition to retirement pensions
A well-publicised strategy ("pension with salary sacrifice") involves setting up a transition to retirement pension, with salary sacrifice of additional amounts to super. The strategy can be designed to ensure:
- the pensioner's superannuation savings continue to grow — despite the fact that they are receiving a pension, and
- the net of tax income level is maintained through a combination of salary and pension income.
Under the current law:
if the person's aggregate benefits have been within RBL, then:
- the pension is generally subject to a 15% tax rebate; and
- the salary sacrificed contributions are not taxed in the individual's hands — but are subject to contributions tax in the fund.
- generally, there are tax savings if the person has room within their RBL. The tax savings arise because by reducing their salary, a person pays less tax.
Also, aggregate superannuation savings may rise as a result of the favourably taxed savings environment in the fund. The strategy can also provide favourable results for a person who is likely to exceed RBL — mainly as a result of time value of money savings as a result of deferring tax.Tax implications - if 2006-07 Federal Budget announcements become law
The 2006-07 Budget proposals contain the following relevant proposals:
- Maintaining the ability to use transition to retirement pensions — with the requirement that the pensions must be non-commutable unless a condition of release is satisfied, eg retirement or reaching age 65;
- Removing the RBL. This would mean that anyone withdrawing a pension and making additional contributions through salary sacrifice would not be constrained by RBL considerations;
- Removing the tax on benefits for anyone over 60. This would make the "pension with salary sacrifice" strategy more tax effective for pensioners over 60 — as the savings in tax on pension income would be higher;
- Restricting the amount of contributions which can be made for a person without tax penalty — the restriction is in the form of high marginal tax rates for amounts in the fund. This is the major factor discouraging the "pension with salary sacrifice" strategy. It imposes constraints on voluntary salary sacrifice for senior employees. These limits will be a vital element in planning. The current proposal is that the general limit is to be $50,000 a year in deductible support. (However, there is a proposed transitional limit of $100,000 a year for people aged over 50 in the contribution year. That transition period lasts for 5 years, from 1 July 2007 to 30 June 2012. There will be lobbying to secure annual indexation of these limits.
If the Budget changes are implemented:
- the "pension with salary sacrifice" strategy is likely to remain efficient, for anyone who can make additional salary sacrifice within the new proposed concessionally taxed limits, and
- the tax savings will be enhanced for people aged over 60 receiving a transition to retirement pension but continuing to work and to salary sacrifice (within the limits).
Enhancing the strategy
There are various enhancements and modifications that can be made to the "pension with salary sacrifice" strategy outlined above — for example:
- combining pension with salary sacrifice and spouse contribution splitting. There has been discussion of the continuing relevance of contribution splitting, given that RBLs are about to be abolished, and that there is no longer a concern that an element of superannuation benefits may become subject to penal tax rates. However, splitting will remain relevant as a way to obtain earlier access to lump sums if either the spouse is able to access benefits earlier than the member, or the splitting spouse intends to retire before age 60.
- achieving a double age-based contribution limit. A person's affairs can be structured so that contributions made by salary sacrifice both absorb the limit for employer contributions, and reduce the employment income to a level below 10% of aggregate income (in this case, "income" includes income from employment, trust distributions, dividends and other investment (or business) income). This double effect gives the member access to the personal contribution deduction (again up to the age based limit) generally available to the person with little employer support. This strategy will have limited life, as it is intended that the Budget changes will prevent access to more than one concessionally taxed contribution limit.
The two example approaches discussed above involve more complexity than merely withdrawing a pension and salary sacrificing to replace benefits. In this context, it is worth considering at what point strategies may come under adverse scrutiny from the ATO as "tax avoidance".
The ATO's current attitude to strategies involving transition to retirement pensions
With any tax saving strategy, it is important to consider whether the approach is likely to be challenged by the ATO under the anti-avoidance provisions of the tax law.
The ATO has issued the following statement in a Media release dated 17 November 2005:
The general anti-avoidance provisions will not apply where taxpayers are simply commencing a transition to retirement pension, and making salary sacrifice contributions to superannuation.
Some strategies have encouraged people to draw down on their superannuation by accessing a transition to retirement pension while, at the same time, salary sacrificing back into their retirement savings. Under these arrangements the pension provides an additional source of income, while salary sacrifice tops up the taxpayer's retirement savings.
Tax Commissioner Michael Carmody said "there has been some media interest recently in the promotion of this strategy. Arrangements entered into in a straight forward way are consistent with the operation of the law, and we do not see grounds for applying anti-avoidance rules.
"For example, an eligible person may take out a pension under the transition to retirement rules. At the same time, that person may engage in an effective salary sacrifice arrangement and contribute to a complying superannuation fund for their own benefit.
"We would only be concerned where accessing the pension or undertaking the salary sacrifice may be artificial or contrived."
On this basis, it seems unlikely that the ATO would pursue an approach which involves only the use of a transition to retirement pension coupled with salary sacrifice to provide future support in retirement. On the other hand, more complex arrangements should be entered into with greater caution and advice should be sought.
In brief, a "transition to retirement pension with salary sacrifice":
- would survive the Budget proposals as a useful strategy for those who can make further salary sacrifice contributions without running into tax penalties for contributions over the concessional tax threshold;
- would be particularly effective for people over 60 — assuming the budget proposals are implemented;
- in its simple form (as outlined in the ATO's Press Release quoted above) would not be challenged by the ATO as an anti-avoidance scheme — according to the ATO's current policy ;
- needs to be considered in light of the potential impact on the pensioner's
- financial position after early withdrawal of benefits,
- level of future benefits, and
- life insurance.
As always, people need advice before setting up these pensions.