Getting all the benefits of transition to retirement strategies

Tim Sanderson considers the benefits of implementing a transition-to-retirement strategy for clients.

A transition-to-retirement (TTR) strategy will be more beneficial to some client situations than others. It is still important, however, to investigate this strategy for clients outside the typical TTR ‘target market’, because many of these clients will still benefit from its implementation. This article highlights the value that can be added for these clients by implementing this strategy.

Background

Since their introduction in 2005, TTR income streams have become a central feature in the retirement strategies of many clients. Primarily introduced to allow for a reduction in working hours prior to full retirement, in practice they are now frequently used as part of a strategy that involves continued full-time work and increased super contributions – the ‘transition to retirement, or TTR, strategy’.

Historically, many advisers have recommended a transition to retirement strategy to clients aged 55 and over, who:

• Have a relatively large existing super balance;
• Are subject to a marginal tax rate (MTR) of at least 30 per cent; and
• Have not used up their concessional contributions cap (concessional cap).

This target market is in the best position to benefit from both the tax-free pension-phase earnings and upfront tax benefit of concessional contributions. These two tax savings combine to make the transition to retirement strategy one of the most effective available for pre-retirement clients.

TTR strategies recommendations have been less common for a number of other client types, particularly those:

• Unable to make further concessional contributions without breaching their concessional cap;
• Subject to a MTR of only 15 per cent; or
• With low super balances.

However, the following examples suggest that TTR strategies are still valuable to many clients in these situations.

Concessional cap already used up

Catherine (age 60 with a MTR of 37 per cent) is already making concessional contributions up to her concessional cap. She has $500,000 in super and wants to retire at age 65. Will she benefit by implementing a transition to retirement strategy in the lead-up to her retirement? You should:

• Use $500,000 to commence a TTR account-based pension;
• Elect to receive a minimum payment of 4 per cent; and
• Re-contribute the minimum payment to super as after-tax contributions (to maintain existing net income).

Analysis one

Catherine will have $34,469 more superannuation available by implementing a TTR strategy that involves after-tax contributions. While she does not receive any additional up-front income tax concessions (as would be the case if she could make further concessional contributions), she still receives substantial tax savings by moving her super balance into pension phase (where earnings are tax-free).

As Catherine has reached age 60, any pension payments are also received tax-free, ensuring that her income tax bill will not increase by implementing this strategy.

A client aged under 60 and in a similar situation to Catherine may still benefit from implementing a TTR strategy. However, the actual outcome will depend on each client’s circumstances, including marginal tax rate and tax components within superannuation.

Low marginal tax rate

Donald (age 60 and working part-time with assessable income of $25,000) has $300,000 in super and wants to retire at age 65. Will he benefit by implementing a TTR strategy in the lead-up to his retirement? You should:

• Use $300,000 to commence a TTR account-based pension;
• Elect to receive a minimum payment of 4 per cent;
• Re-contribute the minimum payment to super as after-tax contributions (to maintain existing net income); and
• Government to make $1,000 co-contribution per year.

Analysis two

Donald will have $26,567 more by implementing a TTR strategy. He receives no upfront income tax concessions, but does benefit by moving his super balance into pension phase (where earnings are tax-free) and receiving a full Government co-contribution each year.

Low superannuation balance

Judy (age 55 with a MTR of 30 per cent) has $70,000 in super (50 per cent taxable component) and wants to retire at age 60. Will she benefit by implementing a TTR strategy in the lead-up to retirement? You should:

• Use $70,000 to commence a TTR account-based pension;
• Elect to receive a maximum payment of 10 per cent; and
• Salary sacrifice to super to eliminate income surplus generated by pension payments.

Analysis three

Judy will have $9,838 more superannuation available by implementing a TTR strategy. When compared with a client who has a much larger existing super balance, clearly Judy cannot receive the same level of benefit.

This is because of a lower level of earnings within super being moved into pension phase, and also because the relatively low pension payment reduces the size of concessional contributions that can be made while still maintaining her existing level of net income.

However, Judy can still receive a clear benefit by implementing this strategy, with the only additional cost being incurred by minor administration fees.

Tim Sanderson is senior technical manager at Colonial First State.