The super pension strategy

Turning a super fund into a pension fund after age 60 is a tax-saving no brainer.

Summary: If you are 60-plus and still working, then a transition-to-retirement pension is a must. Plus what the election result means.
Key take-out: A person still working full-time can use a TTR pension combined with salary sacrifice contributions to receive a tax-free pension at age 60. This strategy can be all the more powerful by recontributing drawn funds back into super as non-concessional contributions.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

If you are over 60 and still working, listen up. This column might be the most profitable column you read this year.

There’s a common misunderstanding around superannuation pensions. And that is that they’re to be taken when you’ve retired.

Sure, that is what they were designed for, so the misunderstanding is understandable.

Further, that’s exactly what the vast majority of Australians will do. Retire somewhere between 60 and 65, then turn on a pension.

But just because it’s logical doesn’t make it right, or good for your finances. Following that plan and retiring at 60 could see you unnecessarily donate tens of thousands of dollars to the Australian Tax Office.

What I hope my Eureka Report columns make clear is that superannuation is, largely, a taxation play. Super investments will almost always beat non-super investments, because at the end of the day, they pay less tax (except for those who are consistently lower-income earners).

SMSFs trustees are largely buying the same assets that they would normally buy outside of super – cash, fixed interest, property and shares. But when income is received and capital gains are made, the investments in super win because of the lower-tax environment.

But that’s not the only thing that is important from a tax perspective.

There are two more tax rules that are crucially important to understand. The first is that when a super fund is turned into a pension fund, it stops paying tax. The second is that when you, the member, turn 60, you do not pay any tax on the income you receive from your pension fund.

Transition to retirement pensions

In 2005, the then Howard government brought in rules designed to allow older working Australians to “transition” from full-time work to retirement, by accessing their super while they were still working. These rules have become known as the “transition to retirement” (TTR) rules.

But there’s nothing in the rules that say that you have to be retiring, or be looking to retire, to access the tax benefits.

You can start a TTR pension, while you’re working, even full-time. Why would you?

Tax-free income stream

Firstly, the income stream that is paid from the TTR pension is tax-free. There’s no tax at all.

So, if you are aged 60, your super fund is worth $500,000 and you turn it into a pension fund, you would need to draw an income of between 4 and 10% from the fund, meaning a tax-free income stream of $20,000 to $50,000.

Contributions strategies

If you’re getting that extra income, then it might help you to make the most of your concessional contributions.

If you’re currently not taking full advantage of your concessional contributions limit ($35,000 for the over-60s for the 2014 financial year, or $25,000 for everyone else), then the extra tax-free pension income stream should allow you to salary sacrifice further into your super fund.

Combining a TTR and salary sacrifice strategy is usually what makes a pension income stream so powerful.

If you are earning $120,000 a year and this strategy allows you to increase your concessional contributions from the employer’s compulsory $9,000 a year to $35,000 via salary sacrifice, then you will have contributed an extra $26,000 to super. This becomes $22,100 after tax (15%), versus receiving $15,990 after losing 38.5% in tax at your marginal tax rate.

There’s a further tax saving of more than $6,100 a year.

Compounding of pension fund tax savings

If your $500,000 fund is earning income of 4% a year, that’s $20,000 a year. Not paying super fund income tax on that means there is $3,000 saved in tax each year in this fund. Further, the fund stops paying tax on capital gains too. What’s that worth to your super fund? This is really a case of “how long is a piece of string?”, as the benefits of not paying tax on capital gains can be considerable. But ultimately it depends on what decisions you make, or would make differently, knowing that gains will not be taxed.

But I don’t need the income and it will deplete my super fund

In the vast majority of cases, not needing the income is irrelevant. And it doesn’t have to deplete your super fund.

While you physically must receive the money into your bank account, you don’t need to really take it. It can be recontributed back into super (into your accumulation fund).

The funds would go back into super as non-concessional contributions, which are subject to their own limit of $150,000 a year. Recontributing as NCCs can also be a part of a powerful estate planning strategy, as it would reduce the tax required to be paid by, for example, adult children if they are to receive your super after death.

A win-win for those over 60

Transition to retirement pensions combined with salary sacrifice are a win-win for those over 60. Literally, if you’re over 60 and not doing it, then you are almost certainly paying more tax (inside and outside super) than you should.

There are very few situations where a combined TTR/salary sacrifice does not make sense. One of these is where someone is already maximising both their concessional and non-concessional contributions. However, even here, it might still make sense to turn their super fund into a pension fund to stop the fund itself paying tax. Or to use the money to contribute to a partner’s super fund.

Federal election – Coalition victory

The election of the Coalition on the weekend puts some certainty around some superannuation changes. But it also introduces some other risks.

See this column (Super choices on the political menu) for a list of the major promises made by the Coalition in regards to superannuation.

The big unknown is the composition of the Senate. That could make implementation of the new Coalition government’s policies difficult.

But it would appear likely that low-income superannuation contributions to credit the 15% tax paid on super contributions for those earning less than $37,000 is dead. It would also appear likely that the increase in the superannuation guarantee from 9% to 12% is also going to be pushed back by two years.

What do we who have such an intense interest in superannuation really want? We want the Coalition to follow through on its overarching superannuation policy. And that was that there would be no unexpected negative changes to superannuation during its first term.

If that promise is delivered on – even without having to make any major improvements to super – then it will go a long way to rebuilding confidence in the superannuation system.

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.


Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au
Graph for The super pension strategy

  • The Australian Securities and Investments Commission (ASIC) has outlined a number of issues it says financial advisers should discuss with clients before setting up a self-managed superannuation fund (SMSF). Among the issues identified by ASIC commissioner Greg Tanzer as requiring discussion between financial advisers and clients were: the roles and responsibilities associated with being an SMSF trustee, the time, cost and resources required to run an SMSF, and the importance of asset diversification within an SMSF.
  • The SMSF Professionals’ Association of Australia (SPAA) says it supports the concerns expressed by the ASIC about aggressive marketing of geared property investment strategies to SMSFs. “There is a role for gearing in an SMSF – but only where trustees have access to best-practice advice from an advisor who is licensed and properly qualified,” said SPAA senior manager, technical & policy, Jordan George. But George also noted that as a policy, gearing is still not widely used among SMSFs. “In our view talk of SMSF gearing being ‘out of control’ is simply not borne out by the facts. At June 2013, SMSF statistics show that only 0.5% of SMSF investments have limited recourse borrowing arrangements, and that this investment category has grown at less than 2% over the past four quarters to 30 June 2013.”
  • Employer superannuation contributions saw their largest decline in the June quarter since the global financial crisis, according to the Financial Services Council’s quarterly Bond report. Employer contributions in the quarter were $489 million, 2.4% lower than the same quarter in 2012. Meanwhile, discretionary contributions over the same period rose 6.6%, or $377 million. FSC chief economist James Bond gave a number of reasons for the decrease, including rising unemployment and slowing GDP growth. “It is also possible that the leakage to SMSFs is taking higher contributing members from the APRA regulated sector meaning there is a step down in contributions to APRA regulated funds,” he said.