Few in the industry saw it coming. There was a general consensus that a looming election would temper any changes to superannuation in the Federal Government’s 2016 Budget. We got it badly wrong. The Government decided superannuation was up for grabs, and proposed the most wide-ranging changes to the system since 2007. With Labor also embracing change, those 2013 commitments by both political parties to leave superannuation intact have joined the growing scrap heap of broken promises.
For advisers, it has meant a frantic reading of the Budget papers to come to grips with the enormity of the possible changes, and advising clients accordingly. Make no mistake, reducing the before-tax contributions cap to $25,000, setting a lifetime after-tax contributions cap at $500,000, and placing a $1.6 million cap on the total amount that can be transferred into a tax-free retirement account have moved the goal posts – to the wing.
While each of these changes has received extensive exposure, another significant implication has slipped under the radar. It will affect far more people than the Government expects.
What were the main benefits of TTRs?
The Government plans to alter the transition to retirement (TTR) rules that were introduced in 2005. Before Treasurer Scott Morrison announced the changes, TTR was considered an excellent strategy for those coming to the end of their working lives and easing their way out of the workforce.
The main benefits were:
- Pay less tax: the TTR pension environment was tax exempt, meaning all income earned and capital gains were tax-free
- Ease into retirement: taking a TTR pension from your super fund could supplement your employment income by topping up your bank account while you reduced your work hours.
The new proposal is to tax the earnings on the assets that support the TTR at 15%. The number of trustees affected is significant with the latest ATO statistics showing that the greatest number of SMSF members is in the TTR age bracket of 55 to 64. About 250,000 SMSF members would have become eligible to benefit from the old TTR rules over the next decade.
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What’s the big change now?
Prior to 3 May 2016, many ‘retirees’ had a plan to leave their superannuation in an accumulation account until they reached the age of 60. Often, they did not start a TTR pension at age 55 (or 56 based on their preservation age) because pension payments would be taxed at their marginal rate less 15%, notwithstanding the tax on earnings in their pension fund would fall to zero. However, on reaching the age of 60, the tax on their pension earnings could also cease, and so the accumulation fund would be switched to a TTR pension fund.
Now, on reaching the age of 60, there are two scenarios possible:
Scenario 1: Continue some form of employment
If a TTR pension is commenced, the earnings on the entire fund will be taxed at 15% until the age of 65, not 60, under the proposals. The $1.6 million limit on tax-free earnings is irrelevant.
Scenario 2: Cease employment
For the earnings in the pension fund to be exempt from tax (on balances up to $1.6 million), the retiree needs to meet a ‘condition of release’, usually ceasing employment.
This change is not a consequence of the much-publicised $1.6 million limit, but the new TTR rules. Many people expect to continue some form of work after reaching the age of 60, and now their entire earnings on their super fund will be taxed at 15%, not only the amount above $1.6 million. This will continue until reaching another ‘condition of release’ – the age of 65.
That’s five years of tax at 15% on all earnings in super which was previously exempt.
To my mind, the Government was strongly influenced by a Productivity Commission report that found TTR strategies were increasingly being used to minimise tax and were not genuinely supporting people wanting to ease their way out of the workforce with many still working the same hours.
But under the proposed regime, from 1 July 2017, all earnings within the TTR pension will be taxed at 15%. In addition, individuals will no longer be allowed to treat certain superannuation income stream payments as lump sums for tax minimisation purposes, with the Government’s rationale being to ensure that access to TTR income streams is primarily for the aim of substituting work income rather than tax minimisation.
The tax-free lump sum cap
In December 2015, the ATO released a private binding ruling which allowed members who are drawing a TTR income stream to take their minimum pension requirement out of their fund as a lump sum instead of as a pension payment. This ruling gave members who were between the age of 55 and 59 an advantage in the tax stakes.
The ATO stated that a member could elect to have this minimum pension amount count towards their tax-free lump sum cap. At present, this cap is $195,000 which meant that members could pull at least $195,000 out of their fund tax-free even if they were under the age of 60. If a member had a tax-free component to their pension this would be even more.
The removal of the tax-free lump sum limit paired with a reduction in the concessional contribution cap and removal of the tax exempt status in the fund will probably mean the end for TTRs. To complicate matters, if we throw in the $500,000 non-concessional lifetime cap, any money we don’t need is going to be tough to get back in.
More questions and doubts
One final question we have relates to the $1.6 million pension income stream cap. Is a TTR income stream arrangement part of this cap even though it isn’t receiving the pension exemption? Do we really want to be switching one on pre-retirement knowing that the cap is going to be indexed and we might be inhibiting ourselves from commencing a larger pension later on?
It seems to me that the Government has thrown the baby out with the bathwater in this latest ‘reform’. By all means police the system to ensure it is being used as the policy makers intended, but to punish trustees who were using TTR to manage the lifestyle change from full-time work to retirement seems overkill.
There are already suggestions that some of the measures won’t stand the test of time, irrespective of which party wins the election. With this mind I am just hoping that no politician promises no changes to superannuation during the course of this election campaign. After the 2016 Budget, we need some change.
Olivia Long is Chief Executive Officer at SuperGuardian. This article is for educational purposes only and does not consider the circumstances of any individual. It is based on an understanding of announcements in the 2016 Budget which may change during the legislation process.