How to get a 0% tax rate on super sooner

My colleague Graham Hand wrote an article last year about the amount of people that do not take advantage of the super pension. He quotes a Class Benchmark Report put out by SMSF administrator Class. It states that while only 12% of SMSF members aged 65 and over remained entirely in accumulation, half of APRA fund members over 65 had not switched any of their super to pension. The amount not switched to pension by over 65s is estimated at $225 billion.

Superannuation allows your investments to exist in two of the most favourable tax rates in our system – at 15% and 0%. Many investors would be stoked with a 15% return, but that is the effective rate that half of APRA members over 65 are missing out on.

Make sure that you’re minimising the tax that you’re paying within super based on your circumstances.

The three main types of superannuation accounts

There are three types of superannuation accounts.

Transition-to-Retirement

You’re able to start a ‘Transition-to-Retirement’ once you reach preservation age. Preservation age depend on when you were born. Most people have a preservation age of 60.

From that age, you’re able to access some of your superannuation, even if you are working full time. A Transition-to-Retirement (TTR) allows you to receive income from your superannuation, with the intention of being able to reduce your work until you transition fully to retirement. However, the TTR can be used to bolster retirement savings while maintaining full time work.

TTR strategies have two purposes from an investment perspective – it allows you to save on tax while increasing your superannuation savings with the tax windfall. This seems counterintuitive at first – you’re pulling money from your super, so how are you saving more for retirement? The proceeds from your super increases your cashflow, allowing you to increase your salary sacrifice from your working salary.

The steps for a TTR typically involve:

Salary sacrifice up to $30,000 into your super at a concessional rate of 15%. Make up to $120,000 in non-concessional contributions after tax.
Receive income from your TTR pension account that replaces the amount that has been salary sacrificed. You’re able to reduce the hours that you work . If you’re able to survive on less than your regular take home pay, you can maximise the amount that stays in your superannuation. These contributions will ultimately be in a 0% tax environment when an account-based pension is commenced.
You receive tax savings – the difference between your marginal tax rate and 15%

If you can survive with a lower take home pay while you are transitioning to retirement, you can maximise your retirement savings by pulling down the minimum withdrawal rate of 4%.

In this example, your take home salary will be $67,225 instead of $74,033. However, you’ll be saving an extra $10,000 into your retirement savings each year.

For $131 less in take home pay each week, you will have $50,000 extra in your superannuation account at 65. That’s $50,000 that will be taxed at 0% once it is in your account-based pension account.

This example does not take non-concessional contributions into account. If you have the savings or capacity to invest further, you’re able to contribute up to $110,000 a year into your super in preparation for retirement. Again, these contributions will be taxed at 0% in your eventual account-based pension.

Using your Transition-to-Retirement to reduce hours

The first case for TTR was to maximise your superannuation balance. The other use for Transition to Retirement is to work less as you ease into retirement.

Life isn’t just about saving. If you’ve gotten to your preservation age and you’re on track to reach your retirement goals, you’re able to draw down on the maximum 10% as illustrated in the table. It means that you can pull back on your hours, and still bring home the same amount of money.

A few factors to consider

If you do take part in a TTR strategy you must keep your accumulation account open. This is the account that is able to accept contributions from outside of superannuation.

It makes intuitive sense, but it is worth noting that if you start a TTR, you may be pulling down on super earlier than you normally would’ve. This means that if you’re simply replacing the funds that are in there, you’re not growing your superannuation in those last few years of your working life. This may result in less retirement savings.

Many investors want to transfer as much as they can into a 0% tax rate environment. There are two main considerations here. The first is that you keep a minimum account balance in your accumulation account. The second is that you maintain that minimum account balance – you will need a buffer for any flat administration fees that are incurred with your account, for potential negative performance, and for insurances.

A TTR is income. If you are on any government benefits that have an income test, it may impact the benefits that you receive.

Life after a TTR

It is possible to start an account-based pension and skip a TTR entirely, if you meet a condition of release. The income that you have depends on how much you transfer to this tax-free account from your accumulation account (taxed at 15%). Currently, the limit is $1.9 million into a tax-free environment.

There are minimum withdrawals on this account, starting at 4%.

Where to go for help

Working out the optimal rates of contributions and withdrawals can be complex.

There are tools online that are there to help you, including IndustrySuper’s TTR calculator.

If you’re with an industry or retail superfund, they will have consultants that will be able to help you understand how TTRs work, the processes to follow and how to set one up if it is right for you. If you hold insurance within your super, they will also be able to let you know whether your policy will be impacted if you start a TTR. This service is usually free of charge.

If you are advised or have an accountant that manages your SMSF, seek advice regarding your personal circumstances on whether this is right for you.