In our blog article two weeks ago, we examined some changes to superannuation contributions that are scheduled to take effect from 1 July. In this article, we continue the superannuation theme, discussing changes to pension arrangements and how you might respond to them.
Superannuation pensions
There are two ways for people to withdraw money from superannuation (at least, while they are still alive!) Where a person chooses to retain most of their benefits within superannuation, and draw a relatively small amount from their superannuation fund each year, that is known as a ‘pension’ or ‘income stream.’
The alternative to an income stream is a lump sum withdrawal. The government tends to dislike lump-sum withdrawals, given people’s propensity to spend what they have withdrawn from their superannuation. Superannuation is intended to reduce people’s reliance on government benefits such as the Centrelink aged pension, and for that reason, there are generally incentives for retaining benefits within superannuation and withdrawing only a relatively small amount as an income stream each year.
Transition to retirement pensions
A transition to retirement pension allows a person who has reached ‘preservation age’ to start drawing income from their superannuation benefits while still working. The original preservation age was 55, but this is increasing gradually and by 2024 it will have increased to 60.
The idea of a transition to retirement pension is to discourage people from completely leaving the workforce. As an incentive to stay in work, when transition to retirement pensions were first introduced, they came with a real kicker: earnings on assets used to finance the pension would not be taxed. Super funds basically became tax-free investment machines for anyone who had reached preservation age.
This was a generous incentive and in the 2016 budget it was decided that it was too generous! As of 1 July 2017, earnings and capital gains on assets used to finance a transition to retirement pension will no longer be tax-free. They will be taxed in the same way that earnings and capital gains are taxed prior to the commencement of a pension – 15% on earnings, and 10% on capital gains for assets that were held for more than 12 months. (Capital gains on assets held for less than 12 months are also taxed at 15%.)
These changes will reduce the appeal of a transition to retirement pension for a lot of people. Basically, the only people for whom such a pension will still appeal are people who really need the money – for example, people working on a very part-time basis.
The changes mean a loss of a tax advantage for many people. But it is difficult to argue that the change is not fair: many, indeed most, people still working beyond their preservation age were simply establishing a transition to retirement pension for the sole purpose of negating tax within the super fund. Indeed, in many cases, the amounts withdrawn from superannuation were simply re-contributed back in in what is called a ‘re-contribution strategy.’
So, transition to retirement pensions will become much less popular from 1 July. However, as we say above, they still do suit certain people. If you are aged 55 or over, or will be soon, and think that a transition to retirement pension may suit your circumstances, please get in touch with us as soon as possible.
Retirement pensions
People aged over 60 who have fully retired, and people aged over 65 regardless of their employment status, can create a pension from their superannuation fund. Earnings on the assets used to finance that pension, including capital gains, are tax-free.
However, from 1 July 2017 this tax-free status will be subject to a limit of $1.6 million worth of assets. People may still retain more than $1.6 million in superannuation, but they can only access the tax exemption on that level of assets. Earnings on assets in excess of $1.6 million are taxed at the standard superannuation rates (15% for income, 10% for capital gains on assets held for longer than 12 months).
To give a simple example, if you have $2 million invested and you generate a 5% income return, then that is a $100,000 return altogether. The return on the first 80% (or $80,000) will not be taxed ($1.6 million is 80% of the total $2 million). The remaining $20,000 will be taxed at the standard super tax rate of 15%, or $3,000. (We have simplified this example to highlight the tax treatment. The two amounts of $1.6 million and $400,000 actually need to be kept within separate accounts within the super fund).
For people whose superannuation benefits are less than $1.6 million, the change has no real effect. For the relatively few people with assets above this threshold, they may now have to pay tax where previously they did not (depending on whether they earn an investment return on the excess amount).
The tax rates that apply to superannuation earnings are still relatively light – but they may exceed tax that would be payable on earnings generated outside of superannuation. If so, it may make sense to remove some money from superannuation.
Much depends on your personal circumstances, so once again, we encourage you to get in touch with us as soon as you can so that we can help you have things in place before the changes take effect on 1 July.