Australian Super and Age Pension Rules

Pinky Uncategorized

Introduction

In this post I go through the Australian Superannuation, Age Pension and Life Annuity rules which are relevant to retirees, and to early retirees in particular. This section can be a bit dry, but it is the foundation of all the other posts as it provides the government rule set applicable to retirees. You can skip this section if you want, and treat it as a reference.

Conventions

Rules around Super, the Age Pension and Life Annuities are constantly changing, including dollar amounts related to rules. When I have quoted a rule or dollar amount, it relates to the beginning of 2015. Where this has changed, I will update with the recent figure and a [20XX] indicating the year that the new figure relates to.

Rules Around Superannuation

In this section I describe the rules that relate to Superannuation and how they will impact on the amount you can spend each year in retirement. I look into the types of funds you may have in your Super account, the age at which you can access your Super, how you can access it, and how you can move funds into, and out of, your account. I also look at the tax implications of these various activities.

Keeping Track of Changes in Rules

Before starting, you probably know that Super rules are constantly changing. I have done my best to provide information relating to the rules at the beginning of 2015. These rules may change. The below sites keep track and provide commentary on Superannuation changes, and can be useful when trying to keep abreast of Super changes that may affect you:

http://superannuationblog.com.au/

http://www.superguide.com.au/

Types of Superannuation

Let’s start with the types of Superannuation you may have in your account. Although most people have preserved funds only, you can have one or more of the following components:

  • Preserved funds
  • Restricted non-preserved funds and
  • Unrestricted non-preserved funds.

I have both preserved and unrestricted non-preserved funds. The history behind the existence of the non-preserved types is complex and I will not go into it here.

Preserved funds in your Super account can be further broken down into several types. These are:

  • Taxed taxable funds.
  • Untaxed taxable funds.
  • Tax free funds.

Most people will have taxed taxable funds in the Preserved component of their Super account. If you have been contributing to Super in the normal way, i.e. your employer has been paying in pre-tax (concessional) contributions and your Super fund has been paying tax on the way in, then the resultant funds are taxed taxable funds.

If your Super fund has not been paying tax on the way in, then the funds are untaxed taxable funds.

If you contribute directly to the fund with after tax income (non concessional contributions) then the funds are tax-free funds.

The way you are taxed on your Super withdrawals depends on the type of funds you have in your Super account, although after 60 all withdrawals are tax free except untaxed taxable funds. For the purpose of this blog, I am assuming the funds in your account are either taxed taxable or tax free.

Why does this matter to early retirees?

  • You may have untaxed taxable funds in your account in which case you will have less take home funds in your Super account than you think.
  • You might want to contribute surplus savings into Super (tax free funds), in which case you need to in understand how these funds are different from the other funds in your account, especially if you intend to withdraw funds before you are 60.
  • If you have Restricted non-preserved funds or Unrestricted non-preserved funds in your account, this affects when you can access your funds.

When can you access your Super

You can access the Preserved component of your Super when:

  • You reach your preservation age and you convince your Super fund that you have now retired. This will involve signing a form provided by your Super fund, stating that you do not intend to work again (or at least no more than 10 hours per week). Your preservation age is between 55 and 60, depending on your date of birth (the earlier you were born, the lower your preservation age is likely to be). See the link later in this section to find your preservation age.
  • You reach 60 and you either stop working, or you are not working when you reach 60.
  • You are over your preservation age and you purchase a “Transition to Retirement” income stream.
  • You are over 65.

For the other components of Super, if you have any:

  • You can access your Unrestricted non-preserved funds at any time. If you have these funds and still paying a mortgage, it may make sense to withdraw them to help you pay it off.
  • You can access your restricted non-preserved funds when you resign from an employment arrangement, or in any of the cases where you can access your Preserved benefit with no cashing restrictions (which I assume means that the Transition to Retirement option is eliminated).

More information about when you can access your Super can be found here.

There is a possibility that the Government may increase the age at which you can access your Super especially as the Age pension eligibility age may change soon. However, as the Government typically makes these types of changes so that they only apply many years in advance, and as I can access my Super tax free in about 8 years time, it is unlikely an age eligibility change will apply to us.

How do you actually get your Superannuation?

Once you decide that you want to access your Super, if you are not working, there are several options you can take:

  • A lump sum (or several lump sums),
  • A fixed income annuity stream,
  • A Transition to Retirement Pension, or
  • An account-based pension.

The way that you are taxed on these options depends on your age (before preservation age, after preservation age but prior to 60, after 60). More information is available on the ato site here.

Most people will not access their Super until 60, because there are disincentives to accessing Super prior to this age. In certain circumstances, however it may make sense to access your Super prior to 60 but after your preservation age, and I will discuss this later in the post.

If you are over 60 and not working, most experts agree that the account based pension is the way to go, and I will base my plan on one of these. But let’s look briefly at the alternatives:

Lump Sums

Lump sums in general are not tax effective, however there may be some circumstances where taking a limited lump sum is worthwhile, especially if you want to access funds prior to 60 and have a specific financially optimised purpose in mind (e.g paying off your mortgage). The reason that lump sums are not tax effective is that the lump sum, or any asset you invest in with your lump sum, attracts tax on the earned interest/income, whereas this is not the case while your investments are in the Super system. If your lump sum withdrawal is large, the interest generated could put you into a high tax bracket.

In addition if you have an account based pension, you can withdraw a lump sum from this fund at any time, which makes withdrawing a lump sum from your Super account somewhat redundant.

Note that when you are over 60, Lump sums are not taxed and prior to 60 and after your preservation age, amounts over the low rate cap ($180,000) are taxed at 17%. More details on the ato site here or more specifically here.

Fixed Income Annuity Streams

The fixed income annuity stream market is poorly developed in Australia and such streams are often not good value. The provider is taking the market risk rather than yourself, and this is priced into the annuity. I’ve looked into how I would fare with an annuity income stream rather than an account based pension here.

Transition to Retirement Pensions?

Transition to Retirement pensions are highly recommended if you are working and you are in a high tax bracket. However, they only make sense if you are working, because account based pensions are basically the same, but have some advantages (so given the choice, you would always take out an account based pension). If you are working, you do not have the option of purchasing an account based pension. See the section on “What if you want to work after all” for more details on Transition to Retirement Pensions.

The Account-based Pension

Assuming you have chosen the account based pension, when you hit 60 there are incentives to moving your funds from your Superannuation account (the account that you have been contributing to over the years, also known as your accumulation account) to this form of pension.

([2016] In the 2016 budget, a general transfer balance cap of $1.6M was placed on the amount of funds that can be moved from the accumulation mode to pension mode).

([2021] This limit was changed via indexation to $1.7M on July 1, 2021. Note that if some funds are transferred to the accumulation mode, the maximum amount eligible to be transferred is the difference between the amount transferred and the general transfer cap index prevailing at the time of the transfer, indexed according to any increase of the general transfer cap.

Thus, for example, if you have $800K in super in 2018, and transfer it all to an account based pension, you are eligible to transfer a remaining $800K in 2018. This changes (assuming no intervening contributions) to $850K (=800K+800K*(1.7M-1.6M)/1.6M) on 1 July 2021.

This can get quite complicated in the case of multiple transfers made at the time of different general transfer caps!).

The main incentive is that you can start to draw an income stream from your pension account, which is not possible from your accumulation account. An income stream is a regular payment going into your bank account from your Pension fund. The other major incentive is that you will enjoy a superior rate of return on your funds when they are located in the account based pension. Superannuation accumulation funds pay up to 15% tax on returns, whereas once your funds are in the pension account, these taxes no longer apply. This can have a significant effect on your balance over the long term.

Some other important characteristics of account-based pensions are:

  • You can withdraw as much as you wish from the account based pension at any time.
  • You must withdraw a certain minimum amount of funds each year. For example, if you are 65, you must withdraw at least 5% of your funds per year.
  • Account-based pensions count as a financial asset and will reduce your Age pension payments (see the section on the Age pension for more information). Note that Accumulation accounts also count as financial assets from the point of view of the Age pension, so keeping money in the accumulation account rather than a pension fund does not have any advantages.
  • Once created, you cannot top up your fund. If you want more account based pension funds, you need to create another account based pension. This will often involve additional one-off and ongoing admin fees.
  • Account based pension fund investments will often be in the markets, so the balance can be volatile.

More information about the minimum withdraw requirement can be found here.

For most Australians, the minimum withdrawal requirement is not an issue because the amount you will want to withdraw will be higher than the minimum. Also, if you are under 65 ([2021] – In the 2021 budget this is to be changed to 74 on 1 July 2022) (or can pass the works test),  you can reinvest any excess moneys that you are forced to withdraw due to the minimum withdraw requirement back into you Super accumulation fund (assuming you still have left a small amount of funds in this account and left it open).

The works test is here.

And for clarity, you pass the works test if  “you have been gainfully employed during the financial year for at least 40 hours over a period of no more than 30 consecutive days.”

As for the mechanics of accessing your funds, I looked up the account based pension on the Australian Super site. If you are in Australian Super, you set up a regular payment from your pension to a bank account, just like you are getting paid from an employer. You can change the amount you pay yourself online at any time. You can also withdraw a lump sum at any time, but there is a $35 admin fee. Maybe in the future some of the funds managers can improve the way you can access your funds – for example an interchange with the banking network so funds can be withdrawn via the national ATM network.

Accessing Super prior to 60

Account based Pensions

 If you are under 60 and over your preservation age, you can also set up an account based pension. However, there are tax disincentives to this because you must pay salaries tax (less 15%) on your income stream while you are under 60.  There are also incentives because at the same time you don’t pay tax on your Super returns (was up to 15%). The diagram below shows the trade offs, assuming your only source of income is your account based pension, and your actual Super return rate was 8%, which is around the industry norm. The area shaded in red/orange is not permissible as it represents spending below the account based minimum spend (4% of fund/year when under 60).

image1

Notice that most of the areas in Green result in an increase in tax. So, for example if you have $300,000 in Super and you take out $80,000 per year, the increase in tax resulting from salaries tax (less 15%) less the reduction in tax resulting from the account based pension being taxed at 0% rather than 15% is about $10,000. There are some areas (circled in red) where you will be paying less tax, although not many. It is not recommended to take out an account based pension prior to 60.

Lump Sums

The other thing to take into consideration is that you can withdraw a tax free lump sum from your Super account during this period, up to a certain limit, the low rate cap ($180,000). Details here.

When you make a lump sum withdrawal, the proportion that is taxed taxable is equal to the overall proportion of taxed taxable in your Super account. So, for example, if you had $800,000 in taxed taxable in Super and $200,000 in tax free, then a lump sum withdrawal of $200,000 would be comprised of $40,000 in tax free and $160,000 in taxed taxable.

So, if you have tax free funds in your Super, the amount you can withdraw tax free is therefore actually higher than the “low rate cap” amount because some of the withdrawal will be in tax free funds, as described above.

If you are like me, and your preservation age is less than 60, it might make sense to put surplus cash that was earmarked for funding retirement between your preservation age and 60 into Super as a non-concessional contribution now. These funds (more than $180K) can be withdrawn tax free at your preservation age. In the interim you should be enjoying better (but riskier) returns while the cash is in Super.

Of course, it would have been even better if I invested it as a concessional contribution as I would have only paid 15% in tax (which means I should have started Super planning prior to 52!).

The alternate to this strategy is that I could just invest the surplus cash in an investment with similar risk to Super. The advantage of putting the funds into Super is the tax rate of around 8%. While this rate is not really a factor if you are not working, most people considering early retirement, including myself, are never sure about when they are going to retire.

The below section has more information on concessional and non-concessional contributions.

Moving money into Superannuation

You can move funds into your Super account that are pre-tax (concessional contributions) or post tax (non-concessional contributions). In general, it is better to make concessional contributions because you only pay 15% tax on funds going in this way, whereas post concessional contributions have already attracted tax at your marginal tax rate. Concessional contributions must be organised via your employer, whereas non concessional contributions are between you and your Super fund.

Non-Concessional Contributions

Non concessional contributions are contributions to Super that you make with your own savings. There is a limit to the amount of non-concessional contributions you can move into Super each year that are tax free, and also there are rules around when you can move the funds into Super. As of 2015, you can move a maximum of $180K per person per year into Super tax-free as non-concessional contributions (although there is an exception – see the below  “bring forwards” rule). Any excess is taxed at 47%. You are taxed at the same rate if you move funds into Superannuation and you are over 65. More information here:

([2016] – In the 2015/16 budget the $180K limit has been reduced to $100K. Furthermore, you cannot contribute any non-concessional funds if your Total Superannuation balance is higher than $1.6M. Your “Total Superannuation Balance” for any given financial year is made up of the value of your accumulation account(s) and the current value of any pension mode accounts that you may have created at the beginning of the financial year under consideration.)

([2017] – In the 2017 budget it was announced that if you are over 65 then up to $300K per member of a couple of the proceeds of selling your home can be moved into Super as a non-concessional contribution and this does not count towards the $100K annual non-concessional limit, and can also be made even if your total Super balance is above $1.6M).

([2021] – In the 2021 budget the eligible age above was reduced from 65 to 60. In addition, the non-concessional cap will be increased to $110K  and the total superannuation balance cap will be increased to $1.7M on 1 July 2021).

The above mentioned exception is that if you are under 65 years old for at least one day of a financial year, you can ‘bring forward’ two years worth of contributions, giving you a total non-concessional contributions cap of $540,000 for the three years, rather than a $180,000 cap in each year of the three years. The three-year period automatically starts from the first year that you contribute more than that year’s non-concessional contributions cap. If you are a couple this figure effectively doubles; you can move about $1M into Super at 65.

([2016] – In the 2015/16 budget the $540K limit has been reduced to $300K. Furthermore, there are now rules about the bring forwards rule when your total superannuation balance is near $1.6M – e.g. if it is more than $1.4M but less than $1.5M you can only contribute $200K using the bring forwards rule and then only over a maximum period of 2 years) and also during the transition from the old $180K limit to the new $100K limit. More details may be found here.).

For those of us who are considering selling our house and moving the funds into Super, the “Bring Forwards” rule is very handy as it allows you to put the proceeds of your house immediately into Super. It means you can avoid interest on the funds from your house sale and hence additional tax.

More information about this here.

Note that you cannot make non-concessional contributions to Super if you are over 65 unless you pass the works test. You cannot make contributions if you are over 75. Refer here for more details.

[2018] In the 2018 Budget it was announced that you can now contribute to Super during the first 12 months after 65 if your Super balance is less than $300K without having to satisfy the works test.

[2019] In the 2019 budget it was announced that voluntary concessional and non-concessional contributions can be made to Super for 65 and 66 year olds without having to pass the works test. This will apply from 1st July 2020. If you are 74 years or below, can you receive Spouse contributions. This provision is yet to become law.

[2021] – In the 2021 budget it was announced you can contribute to Super (concessional, non-concessional, but not personal deductible contributions) up to the age of 74 without having to pass the works test.

Concessional Contributions

There are tax incentives to putting more than the mandated amount of pre-tax income into Super while you are working. This doesn’t apply to me as I am working in a different country and don’t have an Australian income. However, if you are working, and have spare income, then concessional contributions are a tax effective method of contributing to Super because you are only paying 15% tax on your contributions rather than receiving the income at your marginal tax rate. There is a limit to the amount you can sacrifice into Super each year while maintaining the 15% tax break.

The concessional cap limit for people over 50 is presently $35,000. See here.

[2021] This is now $25K and will change to $27.5K on July 1, 2021.

More information about Salary sacrificing in general is here.

Note that you cannot make concessional contributions above the statutory minimum (i.e. Salary sacrificing) if you are over 75.

Concessional Contributions  – Are they fair?

As an aside, it has been suggested that the Australian concessional contribution aspect of Super is unfair because it allows high income earners contribute to Super at low levels of tax. My opinion is that if you believe in the progressive tax system, which I certainly do, there is no doubt that this is an unfair system. There is an interesting article about this in the Sydney Morning Herald:

http://www.smh.com.au/federal-politics/political-opinion/advice-for-hockey-sting-super-and-fix-the-budget-in-one-hit-20141215-1272tu.html

The article points out that the 15% concessional tax rate was introduced by the Labour government in 1992. If Hockey is looking for a way to increase revenue while at the same time increasing the fairness of the Super system, why not tax super contributions at the marginal rate when they enter the fund?

A note about the tax paid on funds in the accumulation account

Superannuation funds pay 15% tax on earning on funds in your accumulation fund. The returns that you see are nett of these taxes. However, the  rate that they pay is actually lower because of things like dividend imputation and rules on Capital Gains Tax that super funds can take advantage of. They actually pay about 6% to 8%, depending on how your funds are invested. This means that the advantage to you when you move your funds into the account based pension are not as significant as otherwise would be the case.

Rules around the Age Pension

The rules relevant to the Australian pension can be found here:

http://www.humanservices.gov.au/customer/services/centrelink/age-pension

For a couple, the maximum pension is presently (September 2014) $1,171 per fortnight, or about $30K per year. With the various supplements, including the clean energy supplement, it is $1288 per fortnight or about $33.5K. ([2016] – In the 2015/16 budget the Energy Supplement, worth about $500, was removed for new pensioners, but retained for existing pensioners).

Pension rates are updated in March and September of each year. Rates are indexed to the maximum of CPI and the PBLCI (and index aimed at working out the cost of living for pensioners). They are also bench-marked at 41.76 of MTAWE for a couple owning their own home (MTAWE = Male Average weekly earnings).

When can you get the Age Pension

Subject to the assets and income test, the pension is presently available to Australians who are 65 years or older. This eligibility age, however, changes in subsequent years. For me and my wife, we won’t be able to get the pension until we are 67. The Australian government is thinking of changing this to 70, so maybe we won’t be able to access it until this age.

More information here:

http://www.humanservices.gov.au/customer/services/centrelink/age-pension

Reductions to the Age Pension

Your pension can be reduced due the assets test, or due to the income test. The reduction is the maximum of the reductions resulting from each of these.

Assets Test

If you have assets (including Superannuation accumulation and account based pension funds, but excluding your home) that exceed certain thresholds, your pension will be reduced or eliminated. At present (Sept 2014) a couple that owns their own home and that has over $1.1455M in assets will not get any pension. For those with less than $1.1455M but more than $286.5k, the fortnightly pension is reduced by $1.50 for every $1000 above $286.5K (for a couple). This is the part pension. There is value being on the part pension (even if the amount paid is very small), as being on the part pension makes you eligible for Senior discounts, which can result in significant cost savings.

[2015] – Note that the pension rules will be changing on Jan 2017, with the part pension being less generous to those with assets.

Asset test limits are updated in January, March, July and September each year.

Further details here:

http://www.humanservices.gov.au/customer/enablers/assets/

Income Test

The pension may also be reduced if you have an income. If you earn more than $248 per fortnight then you lose 40 cents on your pension for every dollar earned above this.

The income test relating to the treatment of account based pensions is changing. As of Jan 2015, this type of pension will be counted as a financial asset and you will be “deemed” to have earned income on this asset. This means that the Australian Government will make the assumption that the asset generates income at a certain rate (irrespective of whether it does or does not). The rate that will apply on Jan 2015 is 2% for funds to $79,600 (for a couple) and then 3.5% for funds beyond this. The existing rules are more complex, but because I am planning for the future and they won’t apply past Jan 2015, I won’t go into these.

More information about this here:

http://www.humanservices.gov.au/customer/enablers/income-test-pensions

Income versus Asset test

It’s a little bit difficult to envisage how the income and assets tests apply in real life and which test applies in which situations. The diagrams below showing some real life examples might help.

This diagram shows how the assets test and incomes test apply assuming that your only asset is Superannuation ($1.26M at 67), you have no income (other than “deemed” income from Superannuation) and spending levels are the same each year.

image1

As the lower value of the assets and income test is applicable, you can see that the asset test applies until right near the end, when the incomes test briefly makes an appearance.

This graph shows how the value of the pension is impacted by a moderate asset of $250,000 (say an investment property) and an income of $10,000. Super is $1.27M at 67.

image1

You can see the assets test is now even more dominant.

The graph below shows how the income and assets test is applicable for various levels of Super and income. Note that the income axis represents income earned, and does not include “deemed” income.

image2

Finally this animation shows how increasing income impacts on the value of the pension. It shows how the pension changes for a couple who start  their retirement with the same level of Superannuation but differing levels of income and have a fixed spend that results in zero Superannuation at 90. Note that in this case increasing income has some effect on the assets test because increasing income means that assets are consumed more slowly.

Pension

Rules around Annuities

Annuities are a class of product that have even more rules than the other (already rule over-laden!) products. The idea behind an annuity is that in return for handing-over your savings/super to an annuity company (usually a Life insurance company), the company will provide you with a regular income stream.

There are the following broad classes of annuities:

  • Lifetime annuities
  • Fixed Term Annuities
  • Deferred Lifetime Annuities

For Lifetime Annuities, the company will pay you (or you and your partner) a regular income stream until death. For Fixed Term Annuities, the company will pay you for a fixed term, and for Deferred Lifetime Annuities (which are not available in Australia at present), the company will pay you from a certain age until death.

Within each class, there are variations. For example:

  • You can choose the income stream to be indexed to inflation, or partially indexed, or not indexed at all.
  • You can choose to be a single owner of the product or you can purchase a joint owner product with your spouse.
  • You can choose a “reversionary”, being the person that the income stream will go to in the event of your death.
  • You can choose to reduce the amount of funds going to the reversionary (or other joint owner) on your death by a certain percentage or not at all.
  • You can choose to get paid monthly, quarterly or yearly.
  • For the Lifetime annuity you can choose to have an option to withdraw the remaining funds in the annuity within a certain timeframe after purchase.
  • You can also choose to have remaining funds in the annuity paid into your estate in the event of your and your reversionary’s death prior to a certain time after purchase of the annuity, with remaining funds going to the company in the event of death after the time period.
  • For the fixed income term product, you can choose for none, some or all of the original capital to be returned to you at the end of the term.

All of these options will obviously have an impact on the regular payment amount that you receive.


Lifetime Annuities

Because I am primarily focused on retirement planning, and I believe Lifetime annuities are the most applicable product, I will focus on this product. Most of the information in this section has been obtained from product disclosure statements on the Challenger web site, http://www.challenger.com.au/products/Lifetime.asp.

The main benefit of the lifetime annuity is that Market Risk (the risk that returns from your product are lower than expected) and Longevity Risk (the risk that you outlive your savings) are eliminated. The main disadvantage is that typically returns are lower than the equivalent returns to account-based pension products. In addition, counter-party risk (the risk that the company that you purchase the annuity from goes bust and can no longer pay you) arises as a new risk.

Lifetime annuities are also handled differently from a taxation and centrelink point of view, and this will be explored below.

There are also some special rules around Lifetime annuities:

  • Although you can purchase an annuity at any age, you can only purchase the annuity from funds rolled-over from the Super system if you are over 60. In addition, the only funds you can roll-over from the Super system are unrestricted non-preserved funds. Typically most people do not have these types of funds (I have about $90K in these funds).
  • If you purchase an annuity from funds rolled-over from the Superannuation system, then your “reversionary” must be your spouse. You cannot purchase a joint owner annuity from funds rolled over from Super. In addition, the income received during the first year must meet the minimum payment rules that were discussed in the account-based pension.
  • You cannot change the reversionary once selected, although you can cancel the reversionary.

Lifetime Annuity Taxation

We know that the income received from the account based pension is tax free. Annuity income taxation is a bit more complicated. Firstly if the annuity is purchased from money rolled-over from Super, income is tax free. However, we saw above that the only money that can be rolled over from Super are unrestricted non-preserved funds, which are not typically held in most Superannuation accumulation accounts. If you purchased the annuity from a source other than unrestricted non-preserved Super funds (which will be the majority of cases), your income is taxed at PAYG salary rates. However there is a deduction allowed for the “return of capital”, known as the deductible amount. This is:

(Initial Capital Amount)/(Relevant Number),

with the Relevant Number being the maximum of the remaining expected lifespan at the time of purchase of each of the joint owners (or the expected remaining lifespan at the time of purchase of the single owner if purchased by a single person). There are more tax rules about how you are taxed if you decide to withdraw the funds in the annuity, and how your estate is taxed if you and your reversionary die within the period during which money is paid into your estate. However, as these rules are not critical to your retirement planning, I will not go into these.

Lifetime annuity and the Age Pension

We saw previously that the account based pension has a significant impact on the Age Pension due to the income test and the assets test. There are another set of rules applicable to lifetime annuities.

Centrelink considers the value of the Lifetime Annuity asset to be the initial value of the capital less the sum of the deduction amounts, as defined above, calculated every 6 months and in arrears.

The income received is considered to be the regular payment amount less the deduction amount. Note that the deduction amount does not seem to be adjusted for inflation, so the income received will increase as time goes on. Also, income received is not derived from deeming on the asset value (unlike the account based pension).

Lifetime Annuity Summary

It’s difficult to assess how the above rules impact on the value of the Lifetime annuity. However annuities are not popular in Australia and I suspect the reasons for this are:

  • Not good value for money when compared with the account based pension, taking into the reduced income due to reduced risk.
  • Lack of control – I am no longer able to take out a lump sum if I need it, for example.
  • Complexity/lack of transparency.

Some vendors of this type of product promote it as a niche product that can be used as insurance to ensure that you have an higher standard of living than would be obtainable by the Age pension alone. The idea is that you put some of your funds into a Lifetime annuity, with the majority going into the account based pension. In the event that the market performs poorly, you always have a certain amount of income, and a certain standard of living above the Age pension, which you can fall back on. So, for example, you could buy a lifetime annuity of, say $10K per year, with the remaining funds going into an account based pension. In the event that the market performs poorly and you run out of funds earlier than expected, you can fallback on the Age Pension + Lifetime annuity of $43K per year. There may be merit in this idea and I will investigate it later in the blog.


SAPTO

SAPTO, or Seniors and Pensions Tax Offset is a rule that allows persons over retirement age to gain a “Tax Offset” against their income. SAPTO is a somewhat mysterious regulation, however the bottom line is that if you are a member of a couple and earn up to $28,974 (in early 2015), you can offset the tax on this income so that you are paying zero tax. If you earn up to $41,790, then you can reduce some of your tax bill. The best link I have to this is the SAPTO calculator:

https://www.ato.gov.au/Calculators-and-tools/Beneficiary-tax-offset-and-seniors-and-pensioner-tax-offset-calculator/

Why do I mention this on an early retirement web site where we expect to be pursuing our own interests by this age and not working? Well, Lifetime Annuity income is considered taxable income. If you have purchased a Lifetime Annuity, then you will be interested in the Arcane SAPTO regulation! (or the even more Arcane LITO regulation which offers the possibility of another small offset).

LISC

The LISC (Low Income Super Contribution) is a scheme that involves the government paying Super funds for low income earners. More information here.

Spouse Contributions [2019]

Its possible to obtain a Tax offset if you make a contribution to your Spouse’s super fund. More information may be found here

The offset is a small amount of no more than $540 (in 2019). You are only eligible for a full offset if your spouse earns less than $37,000, and for a part offset if your Spouse’s income is more than $37,000 but less than $40,000. Your Spouse must be under age 65, or if they’re between 65 and 69 they must be able to pass the works test.

In 2019, the total tax offset is calculated as 18% of the lesser of:

  • $3,000, reduced by $1 for every $1 that the sum of your spouse’s assessable income, total reportable fringe benefits amounts and reportable employer superannuation contributions for the year was more than $37,000
  • the total of your contributions for your spouse for the year.

A tax offset is the reduction in tax the contributing spouse will pay.

Contributions Splitting [2019]

It is possible for some of your non-concessional  Super contributions to be contributed to your Spouse. More details here or here. To receive Super contributions, your spouse must be under preservation age, between preservation age and 65 and not permanently retired, or between 60 and 65 and not terminated gainful employment after reaching age 60.

The maximum amount that can be contributed is the lesser of 85% of the concessional contribution for the financial year and the concessional contribution cap for that financial year.

You can request a contribution split for contributions made in the previous financial year and this request will normally go to your Super fund.

Why would you do Super Splitting? It’s mostly to get around various limits. For example, if you Super is near the $1.6M limit, you could contribute to your Spouse’s super to minimize the possibility you will exceed the limit. Or the amount you could take out of your Super funds tax free between preservation age and 60 (via the low-rate tax threshold) could be boosted if you and your Spouse’s super funds were more evenly matched.

Living Overseas

There are yet more rules that are applicable to retirees living overseas.

The most important ones are summarized in this article:

http://www.afrsmartinvestor.com.au/p/new-investor/how_to_retire_abroad_5WtanqcdvRRyuYPSJPNHYI

Note that:

  • If you intend to retire overseas for a lengthy period, then you will most likely be classified as a “non-resident” for tax purposes.  That means that any Australian-generated income, including your pension but excluding bank interest, is taxed at a 32.5% flat rate. Bank interest is taxed at 10%. Generally you are considered a non-resident for tax purposes if you intend to stay in one country outside Australia for more than 2 years.
  • The rules around CGT on your home are applicable here. Your Australian PPOR will be subject to CGT if you are away from it for more than 6 years.
  • You need to be careful about the tax status of the Age Pension in the country where you choose to live. You may have in-country tax liabilities on the Age pension. If the country you choose to live in has a “double tax treaty” in place with Australia, you may not be liable.
  • Access to Medicare will be removed once you have lived overseas for more than 5 years.
  • If you keep your PPOR in Australia, you may be liable for State Government Land Tax while you are overseas. This can be a significant part of the Age Pension!
  • If you retire overseas early, and you are classified as a Australian non-resident for tax purposes, you may find yourself paying 32.5% flat rate tax on rental income from your Australian real-estate. If you are under 65, this can be effectively reduced to 15% by making contributions to your Super which offset your rental income (see here). Note that your contribution must be less than the concessional rate cap, and also you must derive less than 10% of your income from employment (easy to do if you are not working). You can also take advantage of this strategy if you are a non-resident working overseas.
  • According to this article, http://www.smh.com.au/money/planning/stretched-try-calling-asia-home-20150303-13pyg2.html, if you move overseas, you must have been in Australia for at least 2 years prior to being eligible for the Age Pension. Further information on this here: https://www.dss.gov.au/about-the-department/international/policy/portability-of-australian-income-support-payments

More information on CGT can be found here:

https://www.ato.gov.au/General/Capital-gains-tax/In-detail/International-issues/CGT-and-going-overseas/

“Gifting”

Gifting refers to the practice of pensioners or near-pensioners giving away assets, normally to derive some benefit either to themselves or to their extended family. Mote information here.

Imagine that you are a pensioner couple and have an investment property worth $500K, and you have $500K in Super, for a total asset base of $1m. Under the assets test rule, you will receive a very small part pension (about $210 per fortnight). Your daughter is struggling to save for a house. You may be tempted to sell the investment property, give the proceeds to your daughter, while at the same time increasing your part pension to $960 per fortnight. Your daughter could even repay you some of the gift in undeclared cash payments. Overall the extended family is better off at the expense of the taxpayer.

Well, the gifting rules are designed to prevent this kind of thing happening. If pensioners do not wish to impact their pension payments, they are limited to gifts of no more than $10K per year, and no more than $30K over a rolling 5 year period. If gifts are made in excess of this, then these additional gift amounts are treated as a “deprived asset” from the date of the gift to this date plus five years. This means that, from the point of view of pension payments, you are considered to have this asset for five years and it counts towards both the asset and income test.

So, in the example above, the pensioner couple would continue with the small part pension after the gift (actually it would increase by $15 per fortnight for the first 3 years, in recognition of the $10K limit).

OK, what if you gift the asset prior to starting the pension? Well, there is also a rule which states that the same gifting rule applies to a period five years in advance of when you could reasonably expect to receive the pension.

Basically if you want to gift a significant asset to extended family or friends while you are on the pension (or 5 years prior to receiving your pension), it will impact on your pension payments. It’s better to leave the assets as an inheritance!

What if you want to work after all?

Many people who retire discover that retirement is not for them, and decide to re-enter the workforce. If this is the case for you, the following are relevant:

  • If you retire between your preservation age and 60, you would have signed something with your super fund saying that you intend to retire and not come back to the workforce. If you want to come back, you just need to leave about 6 months between retiring and working again. I understand that an explanation that you changed your mind is acceptable to the tax department.
  • If you are over 60 and you have stopped work, you can automatically get access to Super. You can start working again at any time.
  • If you are over 65, you can access your Super if you are working or if you are not working.
  • If you are over your preservation age, you are in a high tax bracket and you are still working, then there is a very strong incentive to purchase a “Transition to Retirement” income stream. This is very similar to an “account based pension”, however it is “non-commutable”, meaning that you cannot take out a lump sum. In fact, you can only withdraw a maximum of 10% of the funds in the account per year. The advantage of purchasing this type of income stream is that you can salary sacrifice  your income into Super at the same time as withdrawing from the Transition to Retirement income stream, with the effect of keeping your overall level of take home pay the same while at the same time reducing your tax. The Transition to Retirement income stream becomes even more lucrative when you hit 60 because you are no longer paying tax on your Transition to Retirement income stream (prior to 60, this is your marginal rate less 15%, the same as the account based pension). I will not go into these in any additional detail as they are not relevant to early retirees. Note however, you can get the same benefits with the account based pension, the only thing is you can’t start an account based pension if you are still working.

Conclusions

  • This post has provided an overview of the most relevant Government rules which are applicable to early retirees. The rules relate to Superannuation, Age Pension, Annuities and Retiring overseas. I have found the rules to be quite complex and not generally available in the one place. I hope this post has helped to clarify the applicable rules and can assist you with your planning. Where possible, I have referred to the web sites where I have extracted the information, which should allow you to do further research and also to obtain the figures which are most relevant for your situation.

Leave a comment