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The SMSF all-rounder

The change in rules governing transition-to-retirement income streams has made these arrangements more versatile for trustees, writes Tim Miller.

It’s been a turbulent few years for transition-to-retirement income streams (TRIS), but are they coming out the other side a better product? Arguably if they are being paid from an SMSF, they are a vital part of the membership cycle and a key to the estate planning process, not that super is an estate planning vehicle.

When the federal government released amending legislation in February inviting consultation on whether reversionary TRISs should be allowed, the SMSF sector’s response was overwhelmingly yes. In effect what this amendment will provide for is a TRIS being able to automatically revert regardless of whether the reversionary beneficiary had satisfied one of the four nil cashing restrictions that allowed a standard TRIS to move from accumulation phase to retirement phase.

That is big news as it leads to the possibility for a TRIS to be the all-rounder of SMSF strategies.

Salary sacrifice tax deferral

A member, who has attained preservation age but is under 60, will still in many instances benefit from a salary sacrifice and transition-to-retirement strategy. Exchanging salary sacrifice with personal deductible contributions also works, but having reportable employer superannuation contributions can offer additional benefits such as access to temporary incapacity payments if the need arises. In addition, making personal deductible contributions is not as effective as a tax deferral strategy.

Amendments to the Super Guarantee (Administration) Act 1992, which once enacted will ensure salary sacrifice arrangements will no longer reduce, and in many instances extinguish, an employer’s superannuation guarantee (SG) obligation from 1 July 2018, may impact on the number of employers willing to enter into salary sacrifice arrangements. However, for many employees there will still be a benefit to be gained by using this strategy despite the loss of the exempt current pension income (ECPI) deduction for a TRIS in accumulation.

The loss of ECPI within the super environment does reduce the overall tax benefit, but for those currently earning about $80,000 there is still a tax benefit to be had.

Example

Simon, 58, earns $100,000 annually. Let’s assume his employer already pays SG on his pre-salary sacrifice income so he currently has contributions made totalling $9500. Without salary sacrificing, he will pay $26,632 tax (including Medicare) and have a take home pay of $73,368.

If Simon sacrifices $15,000 of his salary into his SMSF, his personal tax liability will be $20,872 with a net take home of $64,128. It is correct to identify that Simon will pay an additional $2250 tax within the fund on the contribution, but this tax is not paid until the fund lodges its annual return so there is a deferral of tax.

If we assume he has $550,000 in his SMSF (based roughly on the average balance for 55 to 59 year olds from recent ATO statistics), it means he can draw between $22,000 and $55,000 as an income stream. Simon doesn’t need that much, so only puts $300,000 into a TRIS. This gives him the capacity to draw $12,000. The reason he only wants $12,000 is that by withdrawing $1000 a month from the SMSF and not claiming the tax-free threshold, Simon’s SMSF will withhold around $70 pay-as-you-go (PAYG) tax per month (after taking into consideration the 15 per cent tax offset) resulting in an annual after-tax income of about $11,000, meaning he is not only paying less tax but he is receiving more income than on the original $100,000. This includes the $2250 tax the fund will pay on the additional contribution. Even if you factor in the earnings the fund has to pay tax on, they are negligible when the capital increase is $15,000.

"Moving beyond preservation age to taking a TRIS at 60 is a no-brainer. The salary sacrifice element to the strategy will continue to be a benefit for all but those in the lowest marginal tax environment."

Tim Miller

The net position is Simon’s income grows, as does his super balance. This assumes a 100 per cent taxable component.

Attaining age 60

Moving beyond preservation age to taking a TRIS at 60 is a no-brainer. The salary sacrifice element to the strategy will continue to be a benefit for all but those in the lowest marginal tax environment. As a generalised statement, it’s probably not a strategy being targeted by that demographic, however, accessing super via a TRIS without the added contribution strategy is still attractive to all.

Non-assessable non-exempt income for withdrawals from super from the age of 60 means that for most, even the smallest contribution and TRIS strategy will benefit clients as they will reduce their overall marginal tax rate.

Of course, as referenced above, the benefit of these strategies has been minimised because of the movement of a TRIS to the accumulation phase rather than the retirement phase, but to suggest those with a TRIS in accumulation phase are paying 15 per cent tax is overstating the tax liability that most funds will pay. Also, as stated above, the fund is deferring the tax on the contribution to the lodgement cycle as well.

If you consider Simon’s example above, then at the age of 60 he can draw the additional monthly amount but without the additional PAYG obligation further increasing his balance in super.

Estate planning

While there are overall tax savings to be made via the use of a TRIS, the greatest benefit they serve may still be the estate planning flexibility and this is only further enhanced once the reversionary laws are enacted.

To understand why, it’s important to understand how certain elements of the superannuation system work.

Separate interests within an SMSF

Members of an SMSF only have one superannuation interest until such time as they commence an income stream. Each income stream commenced gives rise to a new superannuation interest and these interests remain separate up to and including the payment of a death benefit.

Individuals may therefore choose to maintain multiple SMSF pensions for tax and estate planning purposes and this can commence from preservation age.

Commencing an income stream

Unlike lump sums from an accumulation interest, income stream interests only have their tax-free and taxable components calculated at commencement. In income stream interests, all gains, and losses, are proportional based on the component percentages determined at commencement.

TRIS interests

What we are all comfortable with now is that from 1 July 2017 a TRIS is considered to be in the accumulation phase and subject to taxation at the fund level. We also know the initial super reform law was amended to indicate that a TRIS will be considered to be in retirement phase from the member’s 65th birthday or at such time that the member satisfies one of the following conditions of release and notifies the trustees of their fund that the condition has been met:

  • retirement,
  • permanent incapacity, or
  • terminal illness.

The movement from accumulation phase to retirement phase is prospective so will not occur until the member notification is received by the trustee, which in the instance of an SMSF should be instantaneous.

Now it is important to understand a separate interest is still created when a TRIS is commenced, however, that interest may be taxed in the accumulation environment until it meets certain conditions.

Once you can accept that, then you will see a TRIS can still provide some strategic advantages to members that have attained preservation age as existing benefits can be isolated from future contributions, meaning estate planning strategies that previously relied on multiple income streams can still be commenced during the transition-to-retirement stage of an individual’s life.

Starting the estate planning process

Understanding the concept of single versus multiple interests and proportioning can provide significant benefits for estate planning purposes. Lump sum death benefits are not assessable when paid to a tax dependant such as a spouse or a child under the age of 18, however, the taxable component will be taxed at 15 per cent (plus Medicare) when paid to a non-tax dependant such as an adult child.

By establishing more than one income stream interest within an SMSF, a member may be able to distribute benefits upon their death in a more tax-effective manner.

Further, they can start earlier making determinations about what money (and potentially what assets) can be maintained within the super environment, particularly as they are likely to have the ability to pay a reversion regardless of whether they have met one of the conditions indicated above and regardless of whether their spouse has.

The TRIS recontribution strategy

One of the most effective ways to achieve a desirable tax outcome is via a recontribution strategy. The recontribution strategy works best once a member commences one or more income streams as otherwise the member is just re-contributing to an accumulation interest, which will have some tax effect but the contribution value is at risk of being diminished by future investment returns.

The recontribution strategy is generally only considered possible if a member has unrestricted non-preserved benefits enabling them to take a lump sum. This is why pension commencements are usually an opportune time to consider them. Of course, the change in law from 1 July 2017 ensured withdrawals from a TRIS (preserved benefits) could not be accompanied by an election to treat it as a lump sum.

However, given there is no upper limit to how much a TRIS can be commenced for prior to moving to the retirement phase, as a TRIS in accumulation phase is not subject to the transfer balance cap, the 10 per cent maximum withdrawal can also be beneficial. If we assume the majority of TRIS members moving forward will not have access to unrestricted non-preserved benefits, then it’s appropriate to assume most drawings will be income withdrawals subject to PAYG requirements. As such, most strategies are best served from age 60.

Of course, one of the other considerations when contemplating using the recontribution strategies is going to be a member’s total superannuation balance. Members with a total super balance of less than $1.4 million will have no restriction other than the $300,000 cap over three years.

Example

If we consider Simon again, at age 60 he could start drawing the maximum out of his TRIS and if he commenced for the full value, he could take $55,000 in the first year and re-contribute it. He could then commence a second TRIS for the lower balance. He could then repeat the cycle.

The effect is that in one year, and based on the same numbers, Simon’s fund has gone from 100 per cent taxable to 90 per cent taxable and 10 per cent tax-free. The following year he could take the maximum from the taxable pension and minimum from the tax-free and this would significantly impact on the fund for estate planning purposes.

Adding the reversionary rules

By allowing for a TRIS to be reversionary, regardless of the status of the spouse, this opens more doors and makes planning that little bit easier. It also means those existing TRIS members who had a reversion in place don’t need to change the terms of their pensions.

As stated above, the real effect is that a TRIS becomes one of the most versatile strategies in the SMSF sector. It always was, it just got lost for a while.

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