Written by Tracey Scotchbrook, Policy Manager, SMSF Association
In 2017, significant changes were made to superannuation pensions and their associated tax concessions. As a result, transition to retirement pensions seemingly lost some of their shine.
Previously, transition to retirement pensions had been actively used in pre-retirement and tax planning strategies. This was largely due to the tax-free treatment of income, including capital gains, earned from assets supporting the pension. Since 1 July 2017, this tax exemption has been removed for transition to retirement pensions and as a result many thought this was the end for transition to retirement pensions. Indeed, for many people the purpose and strategy for having one was no longer viable.
Despite the loss of the tax concessions, transition to retirement pensions have a role to play and can still be a valuable tool when used in the right circumstances.
What are they?
The original purpose of transition to retirement pensions was to provide a top up source of income for people who have started to make the transition from full time work to retirement. For some, this will be a stepped approach to retirement through the reduction of their working hours or days over time.
Transition to retirement pensions are limited to people who have reached their preservation age. This is the age you can first access your superannuation, subject to meeting certain conditions. Your preservation age depends on when you were born and ranges from age 55 to 60.
A minimum pension payment must be taken each year. For members aged less than 65, the minimum pension rate is normally 4% pa. Due to Covid-19, the minimum pension rates are currently reduced by 50%.
Importantly, a maximum pension payment limit of 10% per annum applies.
The minimum and maximum pension payment amounts are calculated using the pension account balance. Initially on commencement and thereafter, using the opening balance on 1 July each year. If you commence a pension part way through the year, the minimum pension payment is pro-rated based on the remaining number of days in the financial year.
The pension payment amounts must be strictly adhered to. Payments that do not comply, may instead be classed as early access payments and penalties and additional tax may apply.
If you are aged 60 or over, your transition to retirement pension payments are exempt from personal income tax. However, if you are under 60, any taxable portion of your pension will be taxed at your marginal tax rate, reduced by a 15% tax offset.
If you are under 65, and have not retired, your transition to retirement pension does not count towards your transfer balance cap. This means there is no limit on the amount you can hold in a transition to retirement pension.
Besides topping up your income, what are some of the other benefits of having a transition to retirement pension?
They can play a role in your pre-retirement and estate planning strategies.
Quarantine Tax Free Contributions: A transition to retirement pension is still a pension despite its changed tax treatment within the super fund. This means that separate pension accounts can be created within your SMSF. While no accumulation account is present, any tax-free contributions made to the fund, such as non-concessional or small business capital gains tax contributions, can be isolated and the placed into a new tax-free pension.
Recontribution Strategy: Under a traditional recontribution strategy, pension amounts withdrawn are then recontributed back into the SMSF as a tax free non-concessional contribution. This refreshes taxable or substantially taxable components withdrawn to tax free amounts when contributed back into the fund. A new transition to retirement pension can be commenced, securing the tax-free status of the contribution. However, with any contribution strategy, its important to ensure amounts you contribute do not exceed the contribution caps.
Both of the above strategies are useful in minimising the tax payable by adult children on any death benefits they may receive. They also provide a level of protection against any future Government policy changes to the taxation treatment of pensions.
Equalisation of member accounts: Transition to retirement pensions can also be used to equalise member accounts. This can be beneficial for those who may be close to, or over $1.7m and their spouse on the other hand has a smaller balance.
Shifting amounts from one spouse to another allows for greater tax efficiency in the fund. With both members able to maximise the use of their pension transfer balance caps on retirement. Equalisation can also assist in allowing greater amounts to be retained in the superannuation environment on the death of a spouse.
Like the recontribution strategy, the pension is used to withdraw cash from one member account. Subject to the contribution caps, the proceeds are then re-contributed to their spouse’s superannuation account.
Important steps before you retire
If you have a transition to retirement pension, careful planning is essential before retiring or turning 65. At that time, the transition to retirement pension will become a retirement phase pension. Once this occurs the pension will count towards your transfer balance cap and is reportable to the ATO. Penalties apply on amounts in excess of the cap.
A transition to retirement pension in retirement phase will however result in the income from assets supporting the pension to become tax free from that point in time onwards. The maximum pension payment cap of 10% is also removed.
While transition to retirement pensions have their benefits, it is important that you seek advice from a qualified SMSF Specialist Adviser, to determine if this is right for you.
The information contained in this document is provided for educational purposes only, is general in nature and is prepared without taking into account particular objective, financial circumstances, legal and tax issues and needs. The information provided in this article is not a substitute for legal, tax and financial product advice. Before making any decision based on this information, you should assess its relevance to your individual circumstances. While SMSF Association believes that the information provided in this article is accurate, no warranty is given as to its accuracy and persons who rely on this information do so at their own risk. The information provided in this bulletin is not considered financial product advice for the purposes of the Corporations Act 2001.