Year-end tax strategies: the transition phase

Damian Hearn explains the year-end tax strategies available to the self-employed during the transition-to-retirement stage.

One of the most popular strategies for imminent retirees has been the transition-to-retirement (TTR) strategy, but it is important to recognise that it is not limited to employees. The TTR strategy is rarely recommended to self-employed clients (ie, sole traders).

As part of end-of-year tax and retirement planning, your self-employed clients have the opportunity to commence a TTR strategy and reap the benefits.

In fact, this is a significant opportunity because your self-employed clients can obtain the maximum benefit in contrast to your clients who are employees who must commence the strategy at the start of the financial year.

Flexibility for self-employed clients

The foundation of a TTR strategy for a self-employed person is to combine a non-commutable account-based pension (hereafter ‘the pension’) with personal deductible contributions to boost their retirement savings without reducing their after-tax cash flow.

A self-employed client has the flexibility of making personal contributions up to the last day of the financial year.

These contributions can be subsequently claimed as a tax deduction at a later date when the client’s tax return is completed. In contrast, clients who are employees must put in place a salary sacrifice superannuation arrangement at the start of the financial year to obtain the same outcome.

Combining this contribution flexibility with the ability to receive a maximum pension payment of 10 per cent, a self-employed client can make the decision to commence a TTR strategy within the remaining months of the financial year.

The maximum pension payment for the pension is 10 per cent and it is not required by legislation to be reduced on a pro-rata basis if the pension is commenced after 1 July of the financial year.

It is important to check with your product provider if the maximum pension payment is reduced on a pro-rata basis for a mid-year pension commencement.

The product design may not be taking advantage of the freedom afforded under the legislation, and if so, the effectiveness of the strategy will be significantly reduced.

To ensure a self-employed client can access the benefits of a TTR strategy, the pension should be commenced before the personal contribution is made.

As demonstrated within the below case study, this will ensure your self-employed clients can still submit their s290.170 notice of intent to claim a tax deduction form to the superannuation fund.

Careful timing of the strategy is required in order to ensure your self-employed clients are eligible to lodge an s290.170 notice for their personal contributions. Put simply, should the contributions be included (in whole or in part) within the pension, your client will be unable to claim a tax deduction.

The timing of the contributions and commencement of the pension for this strategy is essential. Advisers must also adhere to the strict requirements and the time limits imposed. Failure to do so could result in the tax deduction for personal contributions being denied.

Time limits when claiming

The s290.170 notice must be provided to your client’s superannuation fund before the lodgement of their personal income tax return for the financial year in which they made the relevant personal contributions.

If they do not complete their personal income tax return, they have until the end of the following financial year after the contribution was made to lodge the notice.

Otherwise, they will lose the ability to claim any tax deduction for that period.

Strict requirements

Making the personal contributions prior to commencing the pension will prevent a self-employed client from claiming a tax deduction because the trustee has begun to pay a pension based in whole or in part of the contributions.

In addition, a client must also satisfy the following conditions:

• They must be a member of the fund at the time of claiming the deduction;
• The fund must hold the relevant contributions (ie, before partial/full withdrawal or rollover from the fund); and
• The contributions (either in whole or in part) must not have been covered by an earlier notice.

Case study

Craig (60) is a self-employed IT consultant earning $145,000 per annum and his superannuation account balance is $400,000. He commences a TTR strategy to take advantage of this end of financial year tax and retirement planning opportunity.

To ensure the TTR strategy is successfully recommended to Craig, the following steps need to be taken:

• Commencement of a $400,000 non-commutable account-based pension in May 2011 with a maximum pension payment of $40,000 (ie, $400,000 x 10 per cent);
• A personal non-concessional contribution into his superannuation account of $50,000 prior to 30 June 2011; and
• Prior to the preparation and lodgement of Craig’s personal income tax return to the Australian Taxation Office in mid-October 2011, he will be eligible to submit a valid s290.170 deduction notice.

Continuation into new financial year

A self-employed client can have variable income from one financial year to the next and this may also prevent contributions from being made. You may question whether or not it is worthwhile to continue the strategy should their income substantially reduce.

The answer is quite simple for clients over age 60. The tax-free pension payment needs to be managed in terms of the client’s overall cash flow and it could be re-contributed back into superannuation.

For clients who are aged 55 to 60, it can be more difficult. You will need to complete a tax analysis to determine whether or not it is worthwhile to continue to receive pension payments. Otherwise, it is tax inefficient to continue the strategy.

Self-employed clients aged between 55 and 65 can receive the benefit of the strategy while still working. This is an excellent opportunity to demonstrate the value of the advice that you provide to your existing or prospective self-employed clients on an ongoing basis.

Damian Hearn is technical services manager at IOOF.