Insights Into The Transition To Retirement Strategy (Part 2/3)
We continue with this 10 year anniversary, 3 part series on The Transition to Retirement Strategy.
Let’s now look at what the benefits of the strategy are.
People make use of Transition to Retirement for a variety of reasons. The main ones are:
Many people approaching retirement (that have reached preservation age) choose to work for fewer hours and then use the income drawn from their accumulated superannuation funds to make up for the resulting reduction in income.
The extra income gained from accessing superannuation funds can translate into a material increase in your personal cash flow, especially if you are working part-time. Funds that become available in this way can then either be reinvested if excess to requirements or, with the necessary discretion, used to finance lifestyle goals.
Maximising Retirement Income
Transition to Retirement can also be used to further increase the money available to you in retirement. This can be done by taking advantage of the tax and investment benefits that can be gained by starting a non-commutable income stream from your superannuation fund. An income stream from super will attract advantageous tax rates if you are under 60 and will be tax free if you are over 60. You can ‘salary sacrifice’ a part of your regular income into your super thus lowering your taxable income. This means that the super fund can continue to grow at a healthy rate, despite the fact that you are already drawing a pension.
Here are some Common Questions (& their Answers)
Before you make a decision on Transition to Retirement you should, at the very least, ask yourself the following nine questions:
Question 1 – Is this the right strategy for me?
The answer is, it depends.
Whilst Transition to Retirement can lead to benefits it is not a strategy that should be universally applied. You should, therefore, with the help of a financial advisor sit down and do a full assessment on whether this is the right strategy for you in your particular circumstances. Some of the considerations would be:
- Do I want to start depleting my super early?
- Is the tax benefit worthwhile?
- How much tax will I pay on my pension drawdown (if under 60)?
- Is my super invested in a manner that will benefit me while I implement the strategy?
Question 2 - Do I really want to reduce my working hours and, if so, is the option available to me?
The desire to work less is one of the main reasons why people choose to make use of Transition to Retirement. If you decide to go down this route you need to be 100% sure that you are actually ready (emotionally and professionally) for a time of semi-retirement.
If you can answer in the affirmative you will obviously also have to enquire whether your employer will seriously consider your request for reduced hours.
Question 3 - How will working fewer hours affect my income, and will the income from my super be sufficient to make up any shortfall?
You will have to do a fair bit of number crunching before taking the final step to reduce your working hours. This will enable you to make an informed decision on whether you will be able to maintain your standard of living during this new phase of your life.
Question 4 - How will my choice impact future benefits?
Financial decisions can have very significant long-term implications and are often 3 dimensional. You should therefore do some projections on how your decision to access your pension early will affect your long-term income. This is particularly important when a defined pension, where the benefits are related to age and length of service, is involved.
It should, furthermore always be remembered that being too liberal in accessing your ‘pension pot’ before retirement could leave you with a significant shortfall later in life. This consideration is especially relevant where the Transition to Retirement route is followed in order to maximise current income (as opposed to growing your super fund in a tax effective way).
Question 5 - What will the impact of my choice be on my life insurance arrangements?
It may be the case that your existing life cover ceases or reduces if you access your pension early. The importance of having appropriate insurance arrangements in place cannot be overstated. Ensuring that your insurance cover is up-to-date and appropriate for the Transition to Retirement scenario should therefore receive a very high priority in your planning.
Question 6 - What would the likely tax implications be?
Part of the appeal of Transition to Retirement is that it allows you to benefit from the lower tax rates associated with pension income (the taxable component of pensions is generally subject to a 15% tax offset until you reach age 60). This means that it might be possible to receive part of your income at a lower tax rate while ‘salary sacrificing’ a portion of your income subject to a higher tax rate by adding it to your superannuation fund.
The salary sacrificed contribution will then not be taxed as direct income, but rather in the form of a ‘contributions tax’ to be paid from within the fund. The tax rate at which this is levied is generally much lower than the marginal tax rate that most people pay. Each situation is unique, so take the time to determine whether this arrangement is right for your specific circumstances.
Question 7 – How will ‘Transition to Retirement’ impact my SMSF?
If you have a Self-Managed Super Fund (SMSF) you will need to ensure that you remain on the right side of the SMSF rules while making use of Transition to Retirement. If necessary your SMSF’s trust deed will have to be amended to allow for Transition to Retirement income streams. It may also be necessary to amend the investment strategy of the funds to make sure the cash flows are adequate. Making use of professional advice in order to maintain compliance in this area is highly recommended.
In the next article we at some examples and case studies.
Frank Paul is Chief Operating Officer & Head of Advice Services with Spring Financial Group. Frank has over 20 years' experience in financial planning and investment advisory.
|Frank has extensive experience in private client advising and the management of financial services operations. Frank is actively involved in the recruitment and management of advisory personnel and heads the advisory panel. He holds a Master of Commerce (Financial Planning) and a Dip. Financial Planning and has authored literally dozens of financial education publications.|