By Colin Lewis, Head of Technical Services, Fitzpatricks Private Wealth
Superannuation is the most tax effective savings vehicle you can invest in. It is head and shoulders above the next best investment structure, like a discretionary family trust and/or investment bond.
In the pre-retirement accumulation phase, earnings and capital gains are taxed at a maximum of 15 per cent—and a one-third discount applies to capital gains on assets held for more than 12 months.
In retirement phase, the earnings and capital growth on assets supporting an income stream, e.g. account-based pension (ABP), are exempt from tax.
From age 60, all withdrawals—both lump sum and pension payments—from taxed super funds are tax-free.
You can’t get better than this.
On the flipside, superannuation is locked up—‘preserved’—and cannot be accessed generally until retirement.
Unlike a bank, you cannot just rock up to your super fund and ask to withdraw your savings, regardless of whether you’re in a retail, industry or company fund, or SMSF where you—as trustee—make all the decisions including where to invest your money and whether you can access it.
Just because super from age 60 is tax-free does not mean you automatically get it at that age. There are rules for accessing super. You must meet a ‘condition of release’—generally a life event—before you can take your money out or commence an income stream.
There are 13 conditions of release, including the current temporary compassionate grounds (coronavirus), but most people are reliant on meeting one of the more common conditions for accessing benefits, i.e. they reach their preservation age (currently 58) and retire, or reach preservation age and start a transition-to-retirement income stream (TRIS), or cease an employment arrangement from age of 60, or reach 65 (even if not retired).
At least some super can be released before preservation age in special circumstances including permanent or temporary incapacity, severe financial hardship, compassionate grounds, where the member has a terminal medical condition, or has died.
Take Doug and Joan aged 62 and 58, respectively. They’ve heard of the tax benefits of moving their super into retirement phase, so both want to start ABPs. The problem is they are both working—Doug full-time and Joan 20 hours per week but dropping to 10 hours a week—and Doug has not changed jobs since turning 60.
To commence ABPs, they both need to resign—there must be a full and effective termination of employment where all entitlements, including all unused leave, are paid out.
Doug can work again—he only needs to cease his current employment arrangement—but as Joan is under age 60, she cannot have any intention of returning to the workforce for more than 10 hours a week. Just reducing her work hours to 10 a week doesn’t cut it as there must be a termination of employment.
Doug thought about asking his employer if he could resign one day and start again the next, but was advised against orchestrating a ‘Friday arvo, Monday morning arrangement’ purely to access his super.
As they both do not wish to give up their jobs in the current economic climate, they cannot commence ABPs.
A TRIS on the other hand provides access to super whilst still working.
TRISs are designed to help people ‘transition into retirement’ by allowing them to use their preserved super to supplement their reduced income resulting from scaling back their work hours—but there is no requirement to reduce work hours, or stop work. Anyone from their preservation age can start a TRIS.
Earnings on investments supporting a TRIS are taxed at 15 per cent (unless in retirement phase). SMSFs can offset any franking credits against tax payable and the fund may get a refund of excess franking credits.
Ideally, a TRIS should be commenced from age 60 (unless you need income earlier) when pension payments are tax-free otherwise the taxable component of the pension will be taxed at your marginal rate with a 15% tax offset.
If you’ve reached preservation age and need a little more to live on, then a TRIS may be for you. Alternatively, you may want to reduce non-deductible debt, e.g. your mortgage, personal loan or credit card debt, or need funds to contribute up to the concessional contributions (CCs) cap, currently $25,000 a year. However, if you can salary sacrifice or make a personal deductible contribution from your wage, other earnings or personal savings to maximise the CCs cap, then you don’t need a TRIS—otherwise, you’re taking money out of the concessionally taxed super system and moving it into the taxable environment.
In Doug and Joan’s case, they did not need extra income—especially Joan where that income would be taxable given her age—and their mortgage was paid off, so a TRIS was unsuitable. Their motivation was purely to move into the tax-free retirement phase.
A TRIS converts from accumulation phase to retirement phase when you reach age 65 or notify the trustee that you have met another condition of release, e.g. retirement. The income stream does not cease—it continues subject to the rules for a retirement phase TRIS.
Importantly, earnings become tax-free and the account balance at the time of moving into retirement phase is counted towards your transfer balance cap. The income stream becomes non-preserved, and the commutation restrictions and maximum 10 per cent payment limit of a non-retirement phase TRIS are removed.
If you wish to access your super once you reach preservation age but still work, a TRIS may be for you—however, be mindful for if you commence a TRIS, make sure you’re doing it with the intent of running an income stream.
If your motivation is to get money out of super and you’re thinking of starting a TRIS purely to take out the maximum 10 per cent in one hit and then transferring back to accumulation phase, you may run into trouble. You might have thought about doing this because you need money and are looking to your super, or you’re wanting to reduce your total superannuation balance (TSB) to be eligible to make a non-concessional contribution (or a larger one), or to qualify for the unused CCs cap catch-up, which all have TSB limitations.
The problem is that a pension comprising one payment only is not an income stream, according to the ATO. Accordingly, if you did this, you will not have run an income stream. If you haven’t run an income stream, you could not have had a TRIS. And if you’ve accessed your super while still working without it being a TRIS then you’ve taken your super illegally and that’s a PROBLEM—and there are heavy penalties for breaking the rules around accessing your super early.