Back to basics

Back to basics

The “transition-to-retirement” (TTR) strategy was one of the boons of the Simpler / Better Super reforms that accompanied the introduction of concessional contribution caps from 1 July 2007.

Once the ability to access preserved superannuation funds via a non-commutable income stream was legislated, with the intent to maintain income while reducing working hours and thus “transition to retirement”, it took no time at all the work out that here was a strategy that could effectively replace taxable employment income with tax-effective (or tax-free) superannuation pension income.

But is it as simple as that? Believe it or not, clients want the benefits that a TTR has to offer but along the way they sometimes go awry. I want to look not so much at the concessional contribution caps specifically, but more so at the implications for some important aspects of a TTR strategy that people don’t generally consider, which is why they need quality advice.

Consider the following example that illustrates the application of the strategy that I’m sure we’re all familiar with.

Pre-retiree’s case study

Let’s say Mary is 55 and is earning $110,000 a year – which gives her $79,400 after tax. From this Mary invests $19,400 into superannuation, leaving her with $60,000 to live on each year.

Mary has $250,000 in her super fund (all preserved). She enjoys her job and plans to keep working for another 10 years. However, she realises she needs to increase her superannuation balance at a faster rate.

One way she could achieve this is through the following steps:

  • transfer her super to an Account Based Pension (ABP) under the TTR rule
  • draw $6790 a year income from the ABP
  • salary sacrifice $40,100 a year to super from her salary.

This would result in Mary having the same income to live on each year, made up of:

salary (before tax and after super) $69,900
ABP income                                            $6790
less tax                                                   ($16,690)
Net income                                         $60,000

And, importantly, Mary will accumulate $186,121 more in retirement savings over the next 10 years than if she had not adopted this strategy. The result of this strategy is illustrated in Figure 1.

A $186,121 improvement in retirement savings with reduction in net income Retirement savings

This improvement arises because of the additional contributions Mary makes to super as well as the tax efficiencies created by this strategy – and it has been done with no loss of net income. Once Mary has reached age 60, her income from the ABP is completely tax-free. She does not even have to include it in her tax return. You can see the obvious benefit of the strategy and why it has been so widely adopted by accountants and financial advisers.

Impact of contributions caps

The amount that could be salary sacrificed (or contributed as a deductible personal contribution for self-employed) has always of course been restricted by the member’s concessional contribution cap.

As we know, this limit started off from 1 July 2007 at an indexing $50,000 limit (doubled for people over the age of 50 to a non-indexed transitional limit of $100,000 for a five-year period). But, following the 2009 federal budget announcement, it was reduced by 50 per cent from 1 July 2009. And thus it has stayed for the past two years; a concessional contributions cap of $25,000 (indexed) and a non-indexed transitional cap of $50,000 for those aged over 50 in the year of contribution.

Tricks and traps

1. The need to track concessional contributions

Using the example above, Mary’s income of $110,000 a year would generate superannuation guarantee (SG) of $9900 a year. This added to the salary sacrifice amount of $40,100 brings her total concessional contributions to the $50,000 cap. What about annual bonuses though? Or other payments that carry an SG component – for example, accumulated annual leave that Mary decides to take as cash rather than take the time off work, or long service leave? A $10,000 annual bonus would carry SG of $900. This would be in excess of her $50,000 concessional cap and incur excess contributions tax. The reduction in the concessional contribution cap in 2009 has caught many people out in just this situation.

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