A double income for retirees

When planning for a transition to retirement, advisers now have another strategy for consideration. This new opportunity came about when the Federal Government added a new superannuation condition of release to the existing rules.

Under the new rule, a person of ‘preservation age’ can take their accumulated superannuation benefits in the form of a non commutable allocated pension or annuity, or a non commutable pension or annuity.

This new condition of release does not have any prescribed work test, so a person can continue working in any capacity (for instance, full or part-time) and still be able to draw a non-commutable income stream.

As said, this has provided some clients with another retirement planning opportunity. The strategy involves a person of ‘preservation age’ (now around 55 years) remaining in the workforce. Rather than receiving a salary as income, they may salary sacrifice all (assuming that this is possible under any award or employment agreement) or part of their salary into superannuation. Then, to supplement or replace their income they could commence a non-commutable allocated pension.

The benefits of transition

There are three key benefits to this strategy.

First, the salary that is sacrificed into superannuation is taxed at 15 per cent rather than the client’s marginal tax rate. This could result in a substantial tax savings and could deliver a favourable result for those people that are on higher marginal tax rates.

Higher income earners also no longer have to worry about superannuation contributions surcharge — which is good news — and ensure that a flat rate of 15 per cent will apply to contributions.

Second, the client could transform their income from non-rebateable to rebateable. If the client was to receive their salary normally as income, they would pay income tax in the normal manner (that is, at their marginal tax rates).

If they adopted the strategy and commenced a non-commutable income stream (NCIS) with their superannuation benefits, they could receive up to a 15 per cent rebate on the pension income. The rebate only applies to the rebateable proportion of the pension which represents the non excessive portion.

Next, the superannuation benefits which are used to fund the NCIS will not attract any tax on related investment earnings. If the benefits had remained in the accumulation phase of superannuation, then a 15 per cent tax on investment earnings would apply.

Practical implications

To illustrate, let’s look at the following case study. David, aged 55, works full-time and has a salary of $100,000 per annum. He broadly has two options:

• Option 1: receive his salary and have the relevant tax deducted, or

• Option 2: sacrifice part, or all, of his salary into superannuation and commence a NCIS so that he receives the same amount of net income as in option 1. In this scenario, let’s assume that David wishes to salary sacrifice $70,000 of his salary into superannuation and that he commences a non commutable allocated pension.

If the two options are compared the amount of tax that is paid in the first option of receiving the salary in the traditional method is approximately $30,550. This results in David having a net benefit of $69,450.

Alternatively, if he were to adopt the strategy outlined in the second option, the amount of tax payable is listed in table 2.

Part of the additional tax savings that could result from adopting the second option could be personally contributed to the client’s superannuation account, which may be eligible for the co-contribution. The balance could also be injected into the superannuation system or, alternatively, be used to retire debt or used for other investments outside of superannuation.

Other considerations

When looking at adopting this strategy it is essential that many other factors be explored. The client’s current and future reasonable benefits limits (RBL) situation should be considered in light of this strategy, as the salary sacrifice element (and growth) effectively represents superannuation benefits that will count against the client’s RBL.

When looking at a client’s RBL situation, their previously received benefits (which may need to be indexed) and existing benefits in the accumulation benefits should be considered. In addition, the NCIS may also count against the client’s RBL. Another factor to consider is whether the client’s lump sum or pension RBL will be used.

In addition, advisers should examine the following issues:

Salary sacrifice agreement: If adopting this strategy the client should ensure they enter into an effective salary sacrifice agreement with their employer.

Part IVA: Before adopting this strategy, it is important that the client be aware that the Australian Taxation Office (ATO) is now investigating this strategy in relation to Part IVA and, accordingly, the client should seek expert tax advice before implementing this strategy.

Type of NCIS: A client has a choice of using a non commutable pension or annuity or a non commutable allocated pension or annuity. It should be considered whether the client wishes to be able to make commutations from their income stream when they retire, as only allocated income streams may allow this.

Preservation: The additional contributions that the client contributes to superannuation will be automatically preserved until a condition of release is met.

This strategy, as it presently exists, is worthy of consideration in many transition to retirement plans but, as noted, the ATO may tighten the rules if it believes it is being used for tax avoidance purposes. Then there is the issue of RBLs to consider.

However, there are some instances where this strategy does need to be fully explored and, in many instances, will deliver a significant benefit to retirees.

Carly O’Keefe is an insurance specialist at Tower Australia .