A Transition to Retirement Strategy is predominately implemented as a means of reducing tax payable.
It reduces tax at two levels:
1. Income Tax (via Concessional Contributions)
2. Superannuation Earnings Tax (by converting your balance to pension phase)
Let’s discuss these Transition to Retirement Strategy benefits in more detail
What does a Transition to Retirement Strategy Involve?
A Transition to Retirement Strategy involves salary sacrificing a certain amount into superannuation to reduce your income that tax is assessed on and then drawing a tax-effective (or tax-free) income stream from your superannuation savings (using a TTR Pension) to cover any shortfall in your personal cash flow.
Only employees are able to make Salary Sacrifice contributions. Therefore, if you are self-employed, you would make Personal Concessional Contributions, which would have the same affect.
When can I commence a Transition to Retirement Strategy?
A Transition to Retirement Strategy requires you to commence an income stream from your superannuation savings while you are still working, known as a TTR Income Stream (or Pension). You are only able to commence a TTR Pension once you have reached your superannuation Preservation Age. Therefore, it is at this age that you can commence a TTR Strategy.
Here’s an example of how a TTR Strategy works.
A TTR Pension only allows you to draw an income between 4% and 10% of the account balance, as calculated on 1 July of the financial year. This means that you will need to accurately calculate how much should be salary sacrificed and how much should be drawn as pension income to ensure that you have the ability to continue covering your living expenses.
What are the benefits of a Transition to Retirement Strategy?
The benefits of a TTR Strategy vary and are dependent on the following factors:
- Your level of income (and marginal tax rate (MTR)
- You Superannuation balance
- Your employer contributions
In some instances a TTR Strategy will not provide any benefit.
However, when implemented correctly, a Transition to Retirement Strategy can provide the following benefits:
- Any amount salary sacrificed will not be assessed at your marginal tax rate (MTR), but will be subject to Contributions Tax of 15%. Therefore, provided your MTR is greater than 15%, you will effectively be saving tax. In saying this, if you are under the age of 60, some or all of the income that you withdraw from your TTR pension will likely be assessed at your MTR, less a 15% offset, which will detract from the benefits. Over age 60, all income from your superannuation pension is received tax free (excluding the taxable -untaxed component).
- By converting your superannuation savings into an income stream, all of the earnings received from your investments (including realised capital gains) will be received tax free. This compares to tax of up to 15% being levied in earnings within Accumulation phase.
When will a Transition to Retirement Strategy not be beneficial?
A TTR Strategy may not be beneficial under the following circumstances:
- if your income is less than about $37,000. This is because the personal tax that you pay on your income is less than the 15% Contributions Tax that is payable on your Salary Sacrifice contributions. However, you should factor the Low Income Super Contribution into your equation.
- if you have a high income to the point where your employer superannuation contributions are close to or exceed the Concessional Contribution Cap.
- if you have spoken to your employer and they have advised you that the amount they will pay SG contributions on is your wage AFTER salary sacrifice contributions have been deducted, as this is all that is required by them by law. Therefore, you may be doing yourself an injustice by salary sacrificing into superannuation, as it may reduce the SG contributions. This should be taken into account in any salary sacrifice arrangements, not just a TTR strategy.
How much should I salary sacrifice and how much pension income should I withdraw?
This will be a trial and error calculation, but shouldn’t be a difficult one.
Ultimately, you want to be receiving a net after-tax income that is sufficient to cover your living expenses.
Therefore, you should consider salary sacrificing as much as possible without exceeding the Concessional Contribution cap and without reducing your wage below $37,000, provided that you have the ability to draw an income from your pension to cover any shortfall in cash flow (keeping in mind the maximum 10% income on a TTR Pension).
Stay tuned for a Transition to Retirement Strategy Example in Super Guy post number 46.
What else should I be mindful of?
Remember, access to any amount contributed to superannuation under a Transition to Retirement Strategy is limited until you meet a full superannuation Condition of Release, such as permanent retirement or reaching age 65.