Summary: The government's proposed super changes will make TTR arrangements much less appealing to Australians across all income brackets - though it will still offer some benefits to lower income earners.
Key take-out: If you're over 60 and still working, you have the chance to make the most of TTR - for this year.
Key beneficiaries: Superannuation accountholders and SMSF trustees. Category: Superannuation.
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There's no one killer punch in the Coalition's super shakeup – it's a combination of blows that could bring many great strategies to the canvass.
The reductions of concessional contributions to $25,000 and non-concessional contributions to $500,000, added to the new transfer-to-pension cap of $1.6 million are the big ones that have received much public attention.
But it’s the lower profile changes to the transition to retirement rules that will hit the most Australians.
To some TTR pensioners, the strategy might be better abandoned if the current rules get to the starting line on July 1, 2017. Others might watch a small benefit disappear. There will be some who see a big strategic benefit from the plan become smaller, though still worthwhile.
The TTR rules were introduced in 2006 with the intention of keeping Baby Boomers in the workforce, when there was a shortage of talent. They could cut back from, say, five days a week, to four or three, and top up the income they had lost from fewer working hours, with a super pension.
However, that's not how it ended up being used. In a short period of time, it simply became a tool used by financial advisers to help clients get a tax-free pension income stream (for clients over 60), while salary sacrificing to super at 15 per cent rather than their marginal tax rate.
Add a third benefit of the pension fund itself not paying tax when the pension was turned on and you had a situation where you were pretty much crazy if you were over 60 and hadn't looked into it.
In many cases, it was like finding $10,000 on the ground. Every year in the same place.
As one journalist described it back then, it was, literally, a magic pudding. The more you took out, the bigger the pudding got.
But with the new likely rules, there will be no winners. Just varying degrees of losers.
So, let's look at three situations and try to quantify the financial pain that Treasurer Scott Morrison's TTR changes will cause. In all cases, the planned reduction of concessional contributions from $35,000 (for the over 50s) to $25,000 is as much the cause of losses as the new taxation of pensions.
Everyone in the following examples are employees aged 60-64 (at 65, TTR pensions revert to Account-Based Pensions, whose funds will stop paying tax). We'll also assume that the funds are earning income of 5 per cent a year. We'll ignore capital gains.
1. Higher earner, higher pension balance
Let's assume someone earning $210,000 a year, with a pension balance of $1 million. The fund is earning $50,000 a year in income.
Now, instead of paying $0 on the income earned in the pension fund, the fund will have to pay $7500 in tax on the $50,000 income. That's a new tax.
This employee is also facing a massive reduction in their ability to contribute to super. Earning $210,000 will see their employer pay up to $19,950 in Superannuation Guarantee payments. Where he can salary sacrifice $15,050 in the current financial year, he will be restricted to being able to add just $5050 to his super fund, with a tax concession. The benefit from salary sacrifice has dropped from $5117 a year to $1717 a year, with the decrease from $35,000 to $25,000.
They will still be able to draw $40,000 to $100,000 a year in tax-free income from the fund.
In essence, taxes on the pension fund will rise $7500 a year, while the super tax concessions will reduce by $3400 a year.
The five-year cost, between the ages of 60 and 65, versus the current rules is $54,500.
2. Middle earner, middling pension balance
Let’s look at a pension fund member earning $120,000 a year, with a pension fund of $500,000.
The fund will now have to pay tax on the pension fund's earnings of $3750 a year.
As an employee, they are receiving $11,400 in SG contributions.
They can make a further $13,600 in salary sacrifice. The benefit from salary sacrifice has dropped from $5664 (on $35,000) to $3264 (on $25,000).
Taxes on the fund will have risen by $3750 and the tax benefits from salary sacrifice will have dropped by $2400 a year.
Over five-years, this will cost $24,000.
3. Low earner, low pension balance
With a pension fund of $150,000, this employee is earning $75,000 a year.
The pension fund is only earning $7500 a year, so is only paying tax of $1125 a year, at 15 per cent.
The lower income earner, if they can stretch the budget, has the most to gain from salary sacrifice, however. As they are only having $7125 a year paid in to their super fund as SG, they can salary sacrifice up to $17,875 into their super fund, giving them a tax saving of $3485 a year, down from the $5435 benefit from salary sacrificing up to the $35,000 limit now.
Extra tax paid is $1125 and the reduce salary sacrifice tax benefit is $1950.
Over five years, the extra tax paid is $15,375.
Note: However, this will continue to be a good strategy for those with lower balances. The extra tax to be paid by the pension fund will be relatively small, where the benefits from maximising contributions to the concessional limit, will see people around this income and pension bracket continue to save around $2400 a year in tax.
Everyone will be losers to a degree. But this will still be a reasonable strategy for those with lower super balances and lower incomes and an ability to fund the extra contributions to super.
Will it make sense to turn off the TTR pension? This would turn the strategy into a straight salary sacrifice play. But with a restricted maximum concessional contribution limit of $25,000, this will considerably reduce the benefits here.
The main difference from switching off a TTR pension will be that you don't have to draw down on your fund via a pension.
If you're over 60 and still working, then you have the opportunity to make the most of it for this year. Do so.
There are really only two reasons that those with higher incomes or higher overall super balances would keep their TTR pension going.
The first would be on will be if they physically need the income.
The second would be if they wanted to draw down the income and then possibly recontribute it as a non-concessional contribution to have an impact on the tax plan for non-dependents in the event of their death.
For some, the $500k NCC limit will mean they can't do it anyway. And others might want to keep every cent they can in super, because they are going to be well short of the $1.6m transfer to pension cap.
And if you're earning over $250,000 a year, then you'll be paying 30% tax on your super contributions under Division 293.
The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.