A lower cap for concessional contributions takes the wind out of a popular tax strategy, writes John Collett.
The lowering of the cap on salary-sacrifice contributions to super from $50,000 to $25,000 for those aged over 50, announced in this week's federal budget, could prompt an exit from one of the most popular strategies recommended by financial planners.
When the transition-to-retirement (TTR) strategy was first rolled out more than five years ago, the maximum that could be salary sacrificed into super for those over 50 was $100,000.
The tax savings were substantial for anyone with the spare income to do so.
Even after the cap was cut in the 2009-10 financial year to $50,000, experts still said the strategy was worthwhile for those with reasonable-size account balances.
But experts say that for many people the $25,000 cap, starting on July 1, will mean the cost of implementing the strategy will no longer be worth the tax savings.
Under the strategy, the investor, who must be over 55, draws a pension income while continuing to work and salary sacrificing into super. The idea is to live off the concessionally taxed pension income so more can be sacrificed into super. This way, more tax is saved than from salary sacrificing alone and there is more saved for retirement than otherwise would have been the case.
Usually the strategy is structured so the investor's take-home income remains the same.
The $25,000 cap includes the superannuation guarantee. This means someone on $200,000 a year will have a superannuation guarantee payment of $18,000 (at 9 per cent of pay), leaving only $7000 that can be salary sacrificed.
Given that there are likely to be fees for a financial adviser to implement and manage the strategy, plus product fees, the extra savings from a TTR strategy are likely to be minimal, particularly for those aged between 55 and 60.
The main benefit for 55- to 60-year-olds comes from the fact that there is no tax on earnings inside the pension fund from which an income stream is drawn.
A maximum of 10 per cent of their pension account balance can be taken as a pension income each year. They still pay tax on withdrawals from the pension but get a 15 per cent tax offset on any taxable income.
But the director of financial planning firm Strategy Steps, Louise Biti, says that for those aged 60 or over, the strategy still has potentially significant advantages, mainly because investors can make that draw-down tax free. She says those who are close to 60, and for whom the benefits are marginal, may decide to keep going with the strategy because of the extra benefits from the age of 60.
Colin Lewis, the head of technical services at Ipac Securities, says the lower cap means there is only marginal tax benefits in doing it.
He says the original intent of the TTR rules was to allow those wishing to scale back their working hours to supplement their income from their superannuation savings.
He says for those for whom it was originally designed - over 55-year-olds wanting to scale back their hours - the strategy is still viable.
Fees versus benefit
A planner is needed to implement the strategy. Fees for advice to set up the strategy cost between $2500 and $4000, plus ongoing advice fees and super and pension fund fees.
Figures from financial institutions show the benefits of the strategy in the most favourable light, without accounting for costs.
Even under the most favourable industry scenarios, before and after modelling shows the benefits before costs could be as little as $2000 to $3000 a year for those on higher incomes.
Those who find they are better off unwinding the strategy may be in for a surprise, however.
Those with self-managed super funds can easily unwind the strategy, cost-free, because trustees can just switch the pension back to accumulation without any product fees.
However, those using a TTR strategy with superannuation funds may face exit fees, Biti says.
A financial planner and founder of Hewison Private Wealth, John Hewison, whose clients mostly have self-managed super funds, says every client with the strategy will have it reviewed.
"We will have to re-do the figures and look at all aspects of the current cash flows and future retirement projections," he says. "It is complex and great care has to be taken to get the figures right.
"My gut feeling is that for most people, we will probably retain the transition-to-retirement strategy, but certainly for some, we ... will have to look at alternative arrangements," he says.
Everyone making salary-sacrifice contributions, but especially those aged over 50 who are making use of the $50,000 cap this financial year, must be careful not to breach the lower cap next year, Biti says. Penalties apply for contributions that exceed the caps.
There is little certainty about future caps, making it hard for those saving for retirement to plan ahead.
Before the budget, the government said it would maintain the $50,000 cap for those aged over 50 with an account balance less than $500,000. That was to allow those with low account balances to catch up. The government says it has only delayed this measure until July 1, 2014. But with a federal election due well before the end of next year, there is cause to doubt whether the higher cap for over 50s with low account balances will ever become a reality.