From 1 July 2017, income generated from assets supporting transition to retirement (TTR) pensions will no longer be tax free.
Instead, income and realised capital gains generated by assets supporting a TTR pension will be taxed at 15%, which is the same rate that applies to accumulation accounts.
- The removal of the tax exemption on earnings within TTR pensions, combined with the reduction in the concessional contribution cap to $25,000 pa, reduces the effectiveness of TTR strategies.
- There are no grandfathering provisions and both new and existing TTR income streams will be impacted by the changes.
- The TTR strategy may still be worthwhile, but in more limited circumstances. For example, it may still be effective for someone wanting to reduce their working hours.
- For some clients, there will be little or no benefit in having a TTR pension from 1 July 2017. Furthermore, some people under the age of 60 may actually be worse off by continuing the strategy.
- The benefit of retaining an existing TTR pension should be assessed on a case by case basis. Factors which will determine the viability of a TTR strategy include your age, your marginal tax rate and the taxable components of your member balance.
- Meeting a retirement condition of release has a newfound importance from 1st July 2017. For example, for a person over 60, merely changing an employment arrangement may facilitate the conversion of a TTR pension to an account based pension, and thereby reinstate the tax-free status of the pension.
Transition to Retirement strategies have been a popular way to manage tax and boost superannuation savings. The strategy involved converting your accumulation account into a Transition to Retirement Pension, whilst making concessional contributions.
The strategy involved a tax arbitrage opportunity, as well as the potential to build a bigger superannuation nest egg without reducing current income.
What are the changes from 1 July 2017?
The key changes which will affect TTR strategies include:
- A TTR pension will no longer be eligible for an earnings tax exemption (they will have the same tax treatment that applies in accumulation phase).
- The reduction of the concessional contributions cap to $25,000 from 1 July 2017.
- Removal of the ability to fund pension payments via lump sums, which in some instances provided additional tax advantages.
It’s worth noting that a TTR pension will not have any transfer balance impact (i.e. $1.6m cap on funds to be held in pension accounts), until it is converted to an account based pension.
What is not changing from 1 July 2017?
You can still commence a TTR pension upon reaching preservation age regardless of your work status. Furthermore, there are no changes to the way TTR pension payments are to be taxed or to the minimum and maximum pension requirements.
Taxation of pension payments
- Over age 60, pension payments will continue to be tax-free.
- Under age 60, the taxable component of pension payments is taxed at your marginal tax less a 15% tax offset. There is no tax payable on the tax-free component of the pension.
You must continue to meet the minimum annual pension payment requirements, which for someone under age 65 is 4% of your balance.
The maximum annual pension payment is limited to 10% of the account balance.
Who will still benefit?
The reforms have changed the sweet spot for the TTR strategy. For those who are aged 60 or above, the strategy may still work.
For those who are under 60, the strategy is likely to be difficult to justify. The exception to this rule is where there is a large tax free component in their TTR, which improves the effectiveness of the strategy.
What are your options?
Commute back to accumulation phase
Given there is no longer a tax benefit in continuing a TTR pension, some clients may consider fully commuting their TTR pensions back to the accumulation phase. This may be the case where the additional cash flow generated by the pension is not required.
Continue the TTR pension
Some clients will have a genuine need for additional income and may prefer to continue their TTR pensions. This might be relevant for clients looking to supplement their employment income.
Convert to an account based pension
Where a client has retired or met another full condition of release since starting their TTR pension, it may be possible to commute the pension and use the proceeds to commence a standard Account Based Pension, which will ensure the earnings are tax exempt.
Retirement Condition of Release
If you can meet a “Condition of Release” and convert your TTR pension to an account based pension you will continue to enjoy tax-free earnings after 1 July 2017. In addition, income payments will not be capped at 10% and lump sum withdrawals would also be possible.
The condition of release is met if you have reached your preservation age and either permanently retired or ceased an employment arrangement if you are over age 60.
1. Aged under 60
To satisfy the retirement condition of release, you must cease a gainful employment arrangement and declare that you don’t intend to be gainfully employed for 10 hours per week or more in the future.
2. Aged 60 to 64
This condition is easier to meet, as all that is required is ceasing of any gainful employment arrangement. It is not necessary to retire and it is still possible to work for another entity on a part time or full time basis.
Ceasing an employment arrangement could relate to something as simple as someone already in full time employment agreeing to undertake a short-term contract role, e.g. marking exam papers, working at polling booth etc.
3. Attaining the age of 65 is an automatic condition of release.
Capital Gains Tax (CGT) Relief
To address the perception of the changes being retrospective, the Government has factored in CGT relief for those affected by the new rules. The purpose of the CGT relief provisions is to ensure that capital gains accumulated before 1 July 2017 will be exempt from tax.
Briefly, you have the option to reset the cost base of relevant assets to a current market value. It is not compulsory and the decision can be made on an asset by asset basis. Importantly, the relief only applies to assets owned during the period 9 November 2016 to 30 June 2017; assets purchased after 9 November 2016 will not qualify for the CGT relief. Furthermore, pension assets that are sold before 1 July 2017 will not qualify.
The rules relating to CGT relief are complex and there may be situations where it might be better not to reset the cost base, such as where market value of an asset is less than the cost base. It should also be noted that resetting the cost base will restart the 12-month period for determining future CGT discount upon subsequent disposal of the asset.
In deciding whether to commute or continue a TTR pension, consideration should be given to factors such as your cash flow requirements, contribution capacity and estate planning objectives. Regardless of whether the pension is commuted or continued, consideration should also be given as to whether CGT relief can be and should be applied.
How can we help?
If you are concerned that the Government’s changes to transition to retirement pensions will affect you, please feel free to contact our office on 5229 6882 so that we can discuss your particular situation in more detail.