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The right way to use transition to retirement schemes

July 2019Opinion piece written by John Maroney, CEO, SMSF Association Published in the Financial Review on 19 July 2019
Given the beginning of the new financial year is approaching, many are considering starting or continuing pensions. This also means, it is timely to take a look at transition to retirement income stream options. These streams allow people who have reached preservation age, to access your superannuation benefits without having to retire or leave their job – let’s explore this further.

Overview:

Transition to retirement income streams

Since 1 July 2017, transition to retirement income streams have been divided into two distinct types – taxable and tax-free. Tax-free streams are eligible for a tax exemption on the earnings from assets that support the income stream, while the taxable ones are not. Previously, all streams were eligible for this tax exemption.

This has had significant implications on how transition to retirement income streams are used strategically, as well as what happens to them when someone dies. The main regulatory restriction on retirement income streams is that there is a 10 per cent maximum annual payment and that lump sums cannot be taken.

Tax free or not?

A transition to retirement income stream is tax-free when it is in the retirement phase. When a transition to retirement income stream is in retirement phase, not only are the earnings on the assets tax free, but it will also count towards a transfer balance cap (currently set at $1.6 million of assets that can be in pension phase). A transition to retirement income stream will be in the retirement phase when one of the following conditions are met by a member:
  • age 65
  • retirement
  • permanent incapacity
  • terminal medical condition

The most common scenario for a transition to retirement income stream to enter retirement phase is when a member turns 65. Importantly, this is the only condition where an income in retirement becomes tax-free automatically.

It is therefore important that members approaching 65 with a transition to retirement pension, are aware of this scenario and are monitor their transfer balance cap (super contributions cap). This will ensure they don’t receive an unwarranted transfer balance cap excess tax present on their birthday. For the other conditions of release, it is the member who needs to notify their superannuation fund they have met that condition and want their transition to retirement income streams to move into retirement phase. At this moment the transition to retirement income stream will become tax-free. It is also important to remember that for a transition to retirement income stream to move into the retirement phase, the pension does not need to be stopped and started again. It can happen automatically. The Australian Tax Office also clarified that the 10 per cent maximum and lump sum restrictions fall away when one of these conditions is met. While the income stream doesn’t ever technically become an account-based pension, it effectively is. Given that a transition to retirement income stream is essentially an income stream that begins before meeting one of these conditions, the change from 1 July 2017 to make them taxable is quite significant.

Then, why start a transition to retirement income stream?

The loss of tax exempt status on the income was legislated to bring the use of these income streams closer to their original intent. That is, helping members transition into retirement by supplementing their income with pension payments as they phase out working full time. Furthermore, realised capital gains derived from assets supporting transition to retirement income streams, were designed to aid members as you reduce your working hours. Generally, members will now be more likely to start a transition to retirement income stream to achieve a target level of personal income as opposed to rolling over as much as possible into a transition to retirement income stream before retirement in order to gain tax-free earnings in their fund.

3 main reasons for starting a transition to retirement income stream

There are now three main reasons for starting a transition to retirement income stream that don’t factor its tax status as a consideration:
  1. The first is to continue to work and increase income with pension payments.
  2. The second is to work less hours and top up income with pension payments.
  3. Lastly, maintaining current income levels by salary sacrificing into super and receiving pension payments that reduce tax liabilities and increases super balances is also a reason for some.
It is important to be certain of retirement strategies and objective, and how it fits into a full retirement plan before starting to transition into retirement. If an individual receiving a transition to retirement income stream dies and they haven’t documented that they would like the income stream to continue to their beneficiary, such as a spouse, then the transition to retirement income stream will stop. Read our information on superannuation estate planning to learn more. However, if they have documented that they would like the income stream to continue, it will continue to be paid to their beneficiary and automatically enter the retirement phase, regardless of the beneficiary’s circumstances. With the right strategy, a transition to retirement income stream can be a great tool on your way to retirement. But like any aspect of developing a retirement income strategy, it pays to get expert financial advice first. If you are age 60, or approaching retirement age, speak to an SMSF specialist today to get your super funds in order.   Parts of this article were originally published in the Financial Review on 19 June 2019.

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