First published in the Financial Review on 19 July 2019.
Given it is the beginning of the financial year and many are considering starting or continuing pensions, it is timely to take a look at transition to retirement income stream options.
These streams allow people who have reached preservation age to access their superannuation benefits without having to retire or leave their job.
Since 1 July 2017, transition to retirement income streams have been divided into two distinct types – taxable and tax-free.
Tax-free streams are eligible for a tax exemption on the earnings from assets that support the income stream, while the taxable ones are not. Previously, all streams were eligible for this tax exemption.
This has had significant implications on how transition to retirement income streams are used strategically, as well as what happens to them when someone dies.
The main regulatory restriction on a transition to retirement income stream is that there is a 10 per cent maximum annual payment and that lump sums cannot be taken.
Tax free or not?
A transition to retirement income stream is tax-free when it is in the retirement phase. When a transition to retirement income stream is in retirement phase, not only are the earnings on the assets tax free, but it will also count towards a transfer balance cap (currently set at $1.6 million of assets that can be in pension phase).
A transition to retirement income stream will be in the retirement phase when one of the following conditions are met by a member: age 65; retirement; permanent incapacity; or a terminal medical condition.
The most common scenario for a transition to retirement income stream to enter retirement phase is when a member turns 65. Importantly, this is the only condition where a transition to retirement income stream becomes tax-free automatically.
So, it is important members approaching 65 with a transition to retirement income stream are aware of this scenario and are monitoring their transfer balance cap so they don’t receive an unwarranted transfer balance cap excess tax present on their birthday.
For the other conditions of release, it is the member who needs to notify their superannuation fund they have met that condition and want their transition to retirement income streams to move into retirement phase. At this moment the transition to retirement income stream will become tax-free.
It is also important to remember that for a transition to retirement income stream to move into the retirement phase that the pension does not need to be stopped and started again. It can happen automatically.
The Australian Tax Office also clarified that the 10 per cent maximum and lump sum restrictions fall away when one of these conditions is met and, while the income stream doesn’t ever technically become an account-based pension, it effectively is.
Given that a transition to retirement income stream is generally an income stream begun before meeting one of these conditions, the change from 1 July 2017 to make them taxable is quite significant.
Then why start?
The loss of tax exempt status on the income and realised capital gains derived from assets supporting transition to retirement income stream was legislated to bring the use of transition to retirement income streams closer to their original intent of helping members transition to retirement by supplementing their income with pension payments as they phase out work.
Generally, members will now be more likely to start a transition to retirement income stream to achieve a target level of personal income as opposed to rolling over as much as possible into a transition to retirement income stream before retirement in order to gain tax-free earnings in their fund.
There are now three main reasons for starting a transition to retirement income stream that don’t factor its tax status as a consideration.
The first is to continue to work and increase income with pension payments. The second is to work less hours and top up income with pension payments. Lastly, maintaining current income levels by salary sacrificing into super and receiving pension payments that reduce tax liabilities and increases super balances is also a reason for some.
It is important to be certain of strategy and objective and how it fits into a full retirement plan before starting a transition to retirement income stream.
If an individual receiving a transition to retirement income stream dies and they haven’t documented that they would like the transition to retirement income stream to continue to their beneficiary, such as a spouse, then the transition to retirement income stream will stop.
However, if they have documented they would like the transition to retirement income stream to continue, it will continue to be paid to their beneficiary and automatically enter the retirement phase, regardless of the beneficiary’s circumstances.
With the right strategy, a transition to retirement income stream can be a great tool on your way to retirement. But like any aspect of developing a retirement income strategy, it pays to get expert advice first.
Opinion piece written by
John Maroney, CEO,