Paul Sarkis explains how you can help your clients make the most of the transition to retirement strategy.
Combining salary sacrifice or personal deductible super contributions with a transition to retirement pension (TTRP) can enable your clients to boost their retirement savings without reducing their after-tax income.
However, if you want to optimise the results, there are some very important decisions that need to be made upfront and during the strategy period:
- The amount your client invests in the TTRP;
- How much they contribute to super; and
- The income they elect to receive from the TTRP.
Most clients should maximise the amount they invest in the TTRP. This is because investment earnings in the pension are tax exempt, whereas super fund earnings are generally taxed at up to 15 per cent.
Clients should also maximise their salary sacrifice or personal deductible contributions, as such contributions are generally taxed at a maximum rate of 15 per cent — not their marginal rate of up to 46.5 per cent.
However, when deciding how much to contribute to super each year, it’s important that clients don’t exceed the concessional contribution (CC) cap, which is currently $50,000 per year for people aged 50 or over.
Finally, assuming your clients don’t want to compromise their lifestyle, they should draw enough from the TTRP to maintain their after-tax income.
Rules of thumb for clients with larger superannuation balances
If your client has a larger super balance, is under age 60 and invests the entire amount in the TTRP, they could receive surplus income (even when drawing the minimum payment of 4 per cent).
This surplus income could also be fully taxable — albeit with a 15 per cent tax offset. These clients should only invest enough in the TTRP so the minimum payment doesn’t result in them receiving more after-tax income than they need to maintain their lifestyle.
Conversely, if your client has a larger super balance and is aged 60 or over when the strategy commences, receiving surplus income will generally not be an issue.
This is because the TTRP income will be tax-free and the surplus can be invested in super as a non-concessional contribution. The optimal approach for these clients would therefore be to maximise the amount they invest in the TTRP, draw the minimum and re-invest any surplus income.
Advice for existing clients with a TTRP after July 1, 2012
On July 1, 2012, the CC cap for clients aged 50 or over will reduce to $25,000 per year and will be indexed periodically in increments of $5,000 thereafter.
This change will not affect clients who have been making concessional contributions within the reduced CC cap.
However, if your clients have been making contributions above the reduced cap they will need to contribute less to avoid penalty tax.
Furthermore, if they are under age 60 at this time, they may need to reduce the payments from the TTRP (subject to the minimum) to avoid receiving surplus taxable income. Some of these clients may even need to commute the pension and restart it with a lower amount.
This would only be necessary if they will still receive surplus income when drawing the minimum and the pension comprises a large taxable component.
Finally, if your client is aged 60 or over when the CC cap reduces, they should maintain their TTRP, reduce the income to the minimum and invest any surplus (which will be tax-free) in super as a non-concessional contribution.
Other financial advice issues
- Many of your clients will find their super balance grows over time. One option is to keep the money in super where earnings are taxed at 15 per cent. However, when they reach age 60 or over, they should consider commuting the pension and restarting it with a higher amount so they can get more money into the 0 per cent tax environment (also, any surplus income they receive from the TTRP will be tax-free). This pension ‘refresh’ could be done as a one-off at age 60, or annually from this age.
- When combining personal deductible super contributions with a TTRP, your client should submit a deduction notice before starting the pension. This is because the deduction notice will be invalid if the contribution has already been used in whole, or part, to start a pension.
- When combining salary sacrifice with a TTRP, it’s important that the employer continues to make SG contributions based on the (higher) salary received before starting the strategy. If not, the benefits of this strategy could reduce. Even worse, your client’s retirement savings could be eroded.
- If a client has an unrestricted non-preserved benefit (UNPB) and would like to retain access to this money, they should consider keeping the benefit in super or using it to start a separate pension. This is because all payments from a TTRP will reduce UNPB first, followed by restricted non-preserved and preserved benefits.
Paul Sarkis is head of technical services at MLC.
