There’s never a dull moment in the realm of retirement planning. Just when you thought everything might settle down, up pops some Government policy changes, which cause anyone still working and older than 60 to re-think their strategies. This time it might be a good outcome. The increase in the concessional contributions cap to $35,000 from $25,000 for older workers makes a transition to retirement pension strategy more viable.
The bare facts
Let’s look at an example (summarised in the table below).
John Simpson is 61 and wants to work full-time for another five to 10 years. He receives a salary package of $120,000 per annum. His employer allows him to salary sacrifice as much of his salary as he wants. He and his wife own their home and have one adult child still at home. They need $50,000 a year after tax to live on. His salary package includes his employer’s compulsory super contributions.
Assume that right now his employer contributes the minimum required this financial year (9.25% in 2013/14). This means that John would receive a salary of $109,840 and super contributions of $10,160.
Based on the 2013-14 income tax rates, John will be paying $30,236 tax on his income, including the Medicare Levy (assuming he has no income or access to tax deductions or offsets). Effectively, his after-tax income is just over $79,604.
Total tax, including tax on his super contributions and super earnings, is $39,110. John also has $700,000 in superannuation assets.
He decides to take all his salary as superannuation contributions and to convert his superannuation assets to a pension and to take his income requirements tax-free.
Using this strategy John would save tax by moving his superannuation assets from the accumulation phase (which are taxed at 15%) and moving them to the pension phase (which is taxed at 0%). On $700,000, the tax saving here might be more than $7,350 – assuming a 7% earnings rate in both the accumulation (pre-retirement) and pension phases.
When the concessional contribution cap was $100,000 (during 2007/08 and 2008/09) for those aged over 50, this strategy made a lot of sense for John. With this strategy he would have paid $24,300 tax – a saving of almost $15,000 including the assumed tax saving on his pension assets.
When the concessional cap was reduced to $50,000 for those over 50 in the 09/10, 10/11 and 11/12 financial years, this all or nothing strategy lost its tax effectiveness. In fact, upfront tax in this example would have increased to $40,050.
This strategy became an even better way to pay more tax in 2012/13 when the concessional cap was reduced to $25,000 for all taxpayers.
From 1 July 2013, everything old is new because of two specific changes:
- The increased concessional contribution cap of $35,000 for those aged at least 59 on 1 July 2013.
- The taxation of excess concessional contributions at a taxpayer’s marginal rate
If John took all his $120,000 salary as super contributions, he would pay $25,922 tax – $5,250 on the $35,000 and then $20,672 on his excess contributions (assuming he has no other income). This represents a saving of $13,118 after taking into account the tax savings from the pension tax.
The best outcome
There’s obviously a fair amount of strategizing to be done by John and his financial advisers to make sure he plans well and doesn’t unnecessarily pay too much tax.
Prior to 1 July 2014, some further planning will be necessary for John because of the increased Medicare rate (will be 2%).
In addition, with the Super Guarantee contribution rates increasing each year between now and 1 July 2019, it looks like these strategies will have to be continuously reviewed.
People who are at least 55 but under 60 will also want to revisit their transition to retirement strategies before July 2014 because from that date they’ll be eligible for a concessional contribution cap of $35,000. (Their transition to retirement pension won’t be tax-free but they will receive a 15% rebate on the taxable component portion of their pension.)
Also in the Switzer Super Report:
- Charlie Aitken: Super Sessions with Charlie Aitken
- Barrie Dunstan: Ignore stocks outside the Big Four + one at your peril
- Fundie’s Favourite: Eley Griffiths on STW Communications (SGN)
- Ron Bewley: Discretionary sector – FOX and Crown the pick of the bunch
- Penny Pryor: Buy, Sell, Hold – what the brokers say
- Paul Rickard: Question of the week – pre-retirement assistance needed