The most generous tax concession is available to Australians aged 55 and over, and those who take advantage of it can eliminate all tax payable on applicable investment income and capital gains.
There are even greater savings for people aged 60 and above, with an average income earner on $84,000 able to save almost $5,500 tax per year with no impact to their take home income.
These are just a couple of benefits of a Transition to Retirement Pension.
At its heart superannuation is simply a tax structure. Your super account is a trust that is subject to discounted tax of 15% on investment income and capital gains on the sale of investments held for less than 12 months, or 10% capital gains tax on the sale of investments held for more than 12 months.
If you are aged over 55 you can put up to $35,000 into superannuation before tax, so instead of incurring tax at your marginal tax rate this contribution will be taxed at 15% on entry into your super fund. Included in this $35,000 limit is the compulsory super payment made by your employer.
You can also make after tax contributions of $180,000 per year, or you can bring forward 3 years of contributions and contribute up to $540,000 in 1 year.
Your super fund may also be able to borrow additional funds for investment purposes, for example to buy a property in your self -managed superannuation fund.
Pension Account Basics
Once you reach your preservation age, which up until this financial year was 55, you can switch part or all of your superannuation to pension phase.
As with superannuation this is simply a tax structure, with investment income and capital gains taxed at 0%. Pension payments form part of your taxable income and are taxed at a reduced rate between 55 to 59 years old, and then taxed at 0% from age 60.
The income you receive from your pension after 60 does not even have to be included in your tax return, it is invisible income.
You are required to withdraw a minimum income from your pension, between 55 and 64 its 4% of your balance.
Investment Tax on Earnings in Super and Pensions
Tax on Capital Gains
The difference between what you pay for an investment and what you sell it for is a capital gain (or loss) and is subject to tax. When your super is switched to pension phase there is no capital gains tax incurred at all, and it doesn’t matter when you purchased the asset.
For example let’s say you purchased a property in your self-managed super fund for $700,000, 12 years later you sell the property for $1.4million, that’s a capital gain of $700,000 and therefore your super fund will have to pay capital gains tax of 10% or $70,000.
If the day before you sold, the property was switched from superannuation to pension phase then the capital gains tax payable would be $0, saving you $70,000 for your retirement.
Tax on Investment Income
Any earnings you receive from holding an investment such as dividends, investment property rental income, and managed fund distributions are classed as income and are subject to 15% tax in superannuation.
Once you switch those assets to pension phase there is no tax payable on income. So if we assume our $700,000 investment property above is generating net income of $20,000, that’s a tax saving of approximately $3,000pa.
There is an even bigger advantage when you invest in Australian shares. In Australia we have the franking system which is intended to stop the government double dipping on tax revenue.
When a company earns income they can pay out this income as dividends to investors. The company can choose to pay company tax on this income before they pay out the dividend. When a company pays tax on the income the dividend is said to carry a franking credit, this franking credit indicates to the tax office that tax has already been paid on that income and therefore can be claimed as a tax deduction for whoever the dividend was paid to.
Therefore when you receive a dividend which is fully franked (so company tax has already been paid on it) and you receive it in your pension fund where your tax rate is 0%, then you are eligible for a tax refund of the tax that the company paid on that income.
As an example, if we look at ANZ Bank, this currently has yield of 6.6%, which means if you have $100,000 invested in ANZ it is projected that you will receive yearly dividends of $6,600. However this dividend is fully franked, therefore you will receive an additional 2.8% tax refund. That takes the total yield to 9.4%, or a return of $9,400 on your $100,000 investment.
PAYG Income Tax
Then there was the case of our 60 year old who earns $84,000+super per year saving $5,500 on tax.
With a transition to retirement you contribute as much as you can afford into super before tax, and then take money out of your pension tax free.
Based on only paying in the minimum 9.5% into super, this investor is taking home $63,293 after tax and having $6,783 credit their super account after contributions tax. So their total yearly position after tax is $70,076.
If this investor increased their before tax super contributions to the maximum of $35,000 then their take home pay would reduce to $45,775 and their super contributions would increase to $29,750 after contributions tax. So their total yearly benefit is $75,525. This investor is better off by $5,449 per year.
As for the $17,518 shortfall in take home income, we simply take this as a tax free pension payment assuming their pension balance is sufficient. Therefore the investor has the same take home pay but pays almost $5,500 less tax.
If we combine that to our Investment Tax example client who saved $3,000 tax that would be a combined yearly tax saving of almost $8,500, plus the $70,000 in capital gains tax saved on sale of the investment property.
Is a Transition to Retirement right for you?
Whether commencing a transition to retirement is right for you depends on your circumstances and is something you need to discuss with your financial adviser. However from a tax benefits point of view I am yet to meet a client who did not save tax by commencing a transition to retirement pension.
Fortnum Financial Advisers
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The information provided has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.
The information contained in this article is prepared in good faith based on sources believed to be accurate. However, Fortnum Financial Advisers, or any of the employees, officers or directors do not give any warranty of reliability or accuracy, and, to the extent permitted by law, are not responsible for any errors or omissions (including those due to negligence) contained in the presentation.
For more information, please call Fortnum Financial Advisers on (03) 9909 7553