If you’re nearing retirement age but don’t want to stop working entirely, one option might be to transition into retirement. For those over 60, pension payments from Transition to Retirement (TTR) pensions are tax-free. For those between the preservation age and age 60, a tax offset of 15% applies to pension payments. As such, TTR strategies can be tax effective and can provide several benefits.
Let’s look at some options available to 62-year-old accountant Brian. He works full-time and is on an annual salary of $100,000.
Easing into retirement
First up, Brian might consider reducing his hours as he prepares for retirement. Dropping from five to three days a week will reduce his $100,000 annual salary by $40,000 to $60,000. But as his tax bill[i] also falls, from $24,967 to $11,167, his net income only drops by $26,200. Subject to minimum and maximum pension payment rules, and as the pension payments are exempt from tax, Brian only needs to start a TTR pension paying $26,200 each year to maintain his current lifestyle.
One thing to be aware of
Based on Brian’s reduced hours, his employer’s super contributions[ii] will decrease by $3,740 after the contributions tax of 15% is taken into account. Most simply, Brian could add this amount to his pension payments and make an additional contribution to his super.
Bridging a gap
TTR pensions can also help bridge the gap if household income takes a hit. What if Brian has no plans to reduce his hours, but illness prevents his partner from working for several months? He could start a TTR to tide them over and help meet mortgage repayments or medical expenses. However, once the crisis has passed, the TTR pension will need to continue, as it can’t be withdrawn as a lump sum. Alternatively, it can be converted to a regular account-based pension when Brian turns 65 or permanently retires or is rolled back into the accumulation phase.
Boosting super savings by reducing tax
With his partner restored to health and back at work, and Brian still working full time, what can he do with the now surplus income from the TTR pension? One strategy is to make salary sacrifice contributions to super if Brian does not wish to roll the amount back to the accumulation phase.
Brian may choose to salary sacrifice up to $16,500 of his pre-tax income to superannuation (the difference between the concessional contributions cap of $27,500[iii] less compulsory employer contributions of $11,000). Taken as salary, $5,692 of that $16,500 would go in tax and Medicare levy. Make a concessional contribution to super, and the tax could be reduced to just $2,475, a difference of $3,217!
If there’s still money to spare after the salary sacrifice contribution is made, Brian can look at making after-tax contributions (also known as non-concessional contributions) to superannuation, where the amount contributed is not taxed, and earnings will only be taxed up to 15%, significantly less than his marginal tax rate of 34.5% including Medicare levy.
Getting it right
If you’re approaching retirement, it might be worth checking out what a TTR strategy may be able to achieve for you. It’s a complex area. Eligibility criteria and contribution caps apply, so make sure you talk to us before you act. Penalties may apply for making personal contributions when not eligible to do so OR if you exceed the caps.
[i] Personal income tax estimates in this article include the Medicare levy and exclude tax offsets.
[ii] Based on mandatory employer contributions of 11% of ordinary time earnings from 1 July 2023.
[iii] The concessional contributions cap is $27,500 for the 2023/24 financial year. The cap includes employer contributions, amounts of salary sacrificed, and personal deductible contributions.