ABC of retirement income streams

Andrew Lowe answers some common questions around income stream planning, including eligibility to make super contributions, starting or winding up an income stream, and managing income streams.

The super industry has recently thrown its support behind comprehensive income products for retirement (CIPRs), which the Financial System Inquiry has recommended, and which will provide better outcomes for Australian retirees.

The recent attention on CIPRs means it is now more important than ever for retirement specialists to be skilled up on income stream strategies and its technicalities to help guide the four million plus baby boomers entering retirement over the next two decades.

Income stream planning for clients can be complex due to the interaction, and sometimes apparent conflict, of different laws, which is then compounded by the musical chairs of legislation.

Not only are there myriad pathways to reaching the optimal strategic solution, advisers can often be challenged by time sensitivities relating to advice and the difficulty of accessing client data. Nonetheless, the adviser's ability to effectively steer the client through this complex area demonstrates the clear value of financial advice.

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In this article, we address some of the more commonly asked questions of the ChallengerTech Team in relation to income stream planning — including eligibility to make super contributions, commencing or winding up an income stream, and managing income streams for reversionary beneficiaries and estate planning.

Can my client make a contribution to fund a super retirement income stream?

It depends on the client's age, employment status and capacity within their super contribution caps.

Where a client is less than age 65, they will generally be eligible to contribute to super, irrespective of employment status.

Where a client is at least 65, but less than age 75, they will only be able to contribute to super where they have been "gainfully employed"; i.e. employed or self-employed for gain or reward, for at least 40 hours within a 30-day period during the current financial year.

If a client is at least 75, they generally will not be able to contribute to super (contributions can be received up to 28 days after the member turns 75).

What about the super contribution caps?

Contribution caps will generally limit the amount that can be contributed tax-effectively to super to fund a retirement income stream.

In 2015/16, the non-concessional contribution cap is $180,000 per annum, or $540,000 over three financial years where a client is aged less than 65 at any time during the financial year.

Excess non-concessional contributions made on or after 1 July 2013 can be refunded with earnings on those contributions taxed at the client's marginal tax rate. If a client fails to withdraw those excess non-concessional super contributions from super, they will be taxed at 49 per cent in the fund.

In 2015/16, the concessional contribution cap is $30,000 per annum, or $35,000 per annum for clients aged 49 or over on 30 June 2015.

Excess concessional contributions are taxed at a client's marginal tax rate (less a 15 per cent tax offset).

Excess concessional contributions (less 15 per cent) may be withdrawn from super.

If the client does not withdraw any excess concessional contributions from super, the amount will then count towards their non-concessional super contribution caps.

Can my client make personal deductible (concessional) contributions to reduce taxable income and tax-effectively prepare for the commencement of an income stream?

Personal contributions to superannuation can be claimed as a tax deduction if certain requirements are met, including that less than 10 per cent of income, reportable fringe benefits, and reportable employer super contributions comes from employment.

Once both the age requirements and the maximum earnings test are satisfied, a client can claim a tax deduction for personal contributions if they give the trustees of their superannuation fund a valid notice of intent to claim a deduction. This is subject to the client meeting the approved form and time requirements.

The notice will not be valid where:

• The person is no longer a member of the fund at that time;

• The trustee no longer holds the contribution; or

• The trustee has started an income stream using some or all of the contribution.

The tax deduction for such super contributions can be useful in reducing otherwise taxable income leading up to commencing a super income stream. This is particularly useful, for example, when an individual receives capital gains from selling assets in order to contribute to super.

My client has "retired". Are they able to use their preserved super benefits to commence an income stream?

"Retired" means different things to different people, but when it comes to starting a super income stream, it needs to satisfy the Superannuation Industry (Supervision) Act 1993 (SIS) definition of retirement.

A client is "retired" if they permanently retire on or after their preservation age with no intention to return to gainful employment of more than 10 hours per week at any time in the future.

A client is also "retired" where they cease an arrangement of gainful employment on or after age 60. This will be the case even if they continue other gainful employment or intend to return to gainful employment in the future.

Finally, a client will be "retired" once they are 65, irrespective of their gainful employment or intention to work.

My client does not meet the "retired" definition. Is there any other way they are able to use their preserved super benefits to commence an income stream?

Where a client has reached preservation age, but not otherwise met the retirement condition of release, they may be eligible to access their preserved super benefits in the form of a transition to retirement (TTR) income stream.

The TTR income stream will be non-commutable, meaning it cannot be taken as a lump sum, until a condition of release is satisfied.

How will my client's non-super income stream be taxed?

A non-super income stream (a term or lifetime annuity) may have two components — a deductible amount and an assessable amount.

The deductible amount, if any, is calculated as the purchase price less any residual capital value (RCV) divided by the relevant term or life expectancy. This amount is tax free.

Where annuity payments are greater than the deductible amount, the excess amount is generally assessable income.

Where the annuity payments are less than the deductible amount in any year, no amount is assessable.

Moreover, any excess deductible amount is carried forward to offset income from the annuity in future years.

A client's age does not impact the taxation treatment of non-super income streams.

How will my client's super income stream be taxed?

Super income streams (including account-based pensions and term and lifetime annuities) are tax-free from age 60.

Payments made after attaining preservation age but before age 60 will be taxed based on the super components used to commence the income stream (drawn proportionally).

Any tax-free component will be available tax-free. Any taxable component (taxed element) will be assessable but attract a 15 per cent tax offset.

What is the tax treatment of my client's lump-sum withdrawal of an income stream?

Lump sum withdrawals from super income streams (including account-based pensions and term and lifetime annuities) are tax-free from age 60.

Lump sum withdrawals from super income streams after reaching preservation age but before age 60 will be taxed based on the super components used to commence the income stream.

Any tax-free component will be available tax-free. Any taxable component up to the low rate cap ($195,000 for 2015/16) will be tax-free while any amount above the cap will be taxed at a maximum rate of 17 per cent (including Medicare levy).

How will my client's income stream be assessed for Centrelink Assets Test purposes?

The account balance of an account-based pension will be assessed as an asset.

A 100 per cent RCV annuity will have the purchase price assessed as an asset.

An annuity with an RCV of less than 100 per cent will have the purchase price reduced by the deduction amount over the term of the annuity (or life expectancy for a lifetime annuity).

This reducing asset value can be particularly significant for clients who are Assets Test sensitive, where any reduction in assessable assets could result in an increase in Centrelink benefits.

How will my client's income stream be assessed for Centrelink Income Test purposes?

An account-based pension commenced on or after 1 January 2015 will be deemed.

An account-based pension commenced before 1 January 2015 will retain a deduction amount (where only the income payments received less a deduction amount based upon purchase price will be assessable) where the recipient continues to receive an income support payment and retains the grandfathered account-based pension.

A short-term annuity (an annuity payable for a term of five years or less) will be deemed.

A long-term annuity (an annuity payable for a term of greater than five years, five years or less but equal to or greater than life expectancy, or for life) will have the income paid from the annuity less an annual deduction amount assessed under the Income Test.

What are the estate planning considerations of an income stream?

When considering the estate planning implications of an interest in an income stream, it is necessary to consider how any benefit would be payable. How, and to whom, a super death benefit is paid depends on a number of factors, including:

• The beneficiaries' relationship to the primary policyholder;

• The type of beneficiary nomination in place;

• Whether an income stream (if applicable) is reversionary;

• Provisions of the trust deed of the fund; and

• Trustee discretion

Generally a death benefit paid as a lump sum can only be paid to a dependent that meets the SIS definition, including a spouse, child of any age, dependent or an interdependent, or to the member's estate.

A death benefit paid as an income stream, including a reversionary income stream, can generally only be paid to a dependent.

Where children under 25 have started to receive a death benefit income stream after 1 July 2007, they must stop the income stream and take the remaining benefit as a lump sum on or before the date they turn 25, but the lump sum remains tax free.

How are payments to an estate or beneficiary taxed?

The tax treatment of a death benefit from a super income stream will depend on the components of the benefit, the recipient and the form of the benefit, as shown in Tables 1 and 2 (lump sum or pension).

Table 1: Tax of super lump sum payments made to the estate or beneficiaries:

Table 2: Tax on the taxable component of a benefit paid as an income stream to a dependant:

The super industry's growing interest in retirement income streams means retirement specialists are well positioned to take the lead on understanding the treatment and technicalities of income streams to support their clients.

Australia's ageing population and increasing longevity means retirement specialists have never been more important, and are in pole position to demonstrate clear value to their clients.

Andrew Lowe is the head of technical services at Challenger.