A number of recent changes to superannuation have had a significant impact on the wealth creation capacity of transition to retirement strategies. Martin Breckon weighs up their effectiveness following these changes.
Transition to retirement (TTR) pensions, combined with salary sacrifice arrangements, remain a powerful wealth creation strategy — even with all of the superannuation changes last year.
Impact of recent superannuation changes
However, some of the taxation effectiveness has been diluted by a combination of factors.
These factors include the halving of the concessional contributions, and the inclusion of salary sacrifice contributions as Reportable Employer Superannuation Contributions for the income tests for the Mature Age Workers Tax Offset, the Senior Australians Tax Offset and the Superannuation Co-contribution.
A simple example of this follows. Allan, who is aged 57, earns $65,000 salary, net of super guarantee, and earns no income from other sources.
He salary sacrifices $17,000 and makes a personal contribution of $400.
Withholding tax
Despite this, TTR pensions are still effective. However, a misunderstanding of how pension withholding tax works before the age of 60 may trigger significant unexpected taxation consequences.
Pension payments may consist of a proportion of the tax-free component and taxable component. The latter is assessable income up to age 60 and is subject to Pay As You Go (PAYG) withholding tax and may have the advantage of a 15 per cent tax offset.
The amount to be withheld from payments is primarily determined by the information provided in a tax file number (TFN) declaration (NAT 3092).
A TFN declaration applies to future payments, that is any payment made after the declaration is provided to the payer. The only way a payee can amend a declaration is by submitting a new declaration.
PAYG withholding instalments are deducted at the time of the pension payment. The amount of tax deducted is prescribed by the Australian Taxation Office and depends on:
- the amount of the pension payment and its frequency;
- whether the tax-free threshold is claimed;
- whether there is a tax-free amount due to a tax-free component at commencement;
- entitlement to a tax offset (formerly called a rebate) on taxable income; and
- the age of the pensioner — all pension payments from a taxed superannuation scheme are tax-free from age 60.
The client receives a PAYG Payment Summary from each PAYG payer after the end of the financial year detailing the amount of PAYG withholding instalments deducted throughout the year.
Unfortunately, each PAYG payer does not take into account taxable income from other sources (e.g, multiple PAYG payers, investment income and assessable capital gains).
It is quite possible that the combined total taxable income moves the client across tax thresholds when the individual’s tax return is assessed. This can result in too little tax withheld by each payer throughout the year, and an unexpected tax liability for the individual.
Example
Allan earns $65,000 net of superannuation guarantee and salary sacrifice. He also receives $35,000 taxable pension income from his transition to retirement pension.
Allan’s $6,000 tax-free threshold is claimed by his employer. For simplicity, we have excluded the Medicare levy and any possible tax offsets other than the 15 per cent pension tax offset. See table 2 and 3.
If this is not planned for at the start of the strategy, at the end of the financial year the client may face an unanticipated tax bill. In Allan’s case, the bill is for $5,350.
Ignoring other potential allowable deductions and offsets, the client has two alternatives:
- anticipate a tax liability by making a provision out of savings; or
- complete and lodge a withholding variation at the start of the financial year.
What is a withholding variation?
Under tax law, the Commissioner of Taxation may, to meet special circumstances, vary the amount that a payer (such as your superannuation fund or employer) is required to withhold.
The main purpose is to ensure that the amounts withheld during the income year best meet end-of-year tax liabilities.
The variance may increase or decrease tax withheld.
An upwards variation can be arranged by entering into an agreement with your payer to vary the rate or amount of withholding tax.
The payee and the payer will need to complete a Withholding declaration — upwards variation (NAT 5367). Once completed, the payer will return the agreement to the payee and keep the declaration for their records.
Generally, the individual would give it to the employer.
The amount withheld can be expressed as a percentage or as an additional dollar amount per payment. A client can agree with the payer to have the rate or amount of withholding increased to suit individual circumstances and cover the tax payable on other income such as interest or rent.
The upwards variation agreement can be ended at any time with written notification to the payer requesting the amount withheld from future payments be in accordance with the PAYG withholding tax tables, or at a rate specified by regulation — not at the increased rate.
The potential confusion and resulting increase in tax described above highlights the importance of knowing what a client’s total income for a future financial year is going to be.
Consequently, being aware of a client’s income from all sources at the start of the exercise and upwardly varying the withholding tax to avoid a future tax liability is a valuable contingency tool.
Alternatively, excess amounts withheld will not be refunded until the individual income tax return is submitted and assessed. For some clients, making a provision in their savings may be far more convenient.
Martin Breckon is technical marketing manager at Aviva Australia.
