All too often when I hear people talking about the transition to retirement strategy, I hear about a two-stage process involving the sacrifice of pre-tax salary into super that is then followed by the commencement of a TTR income stream to supplement the cash flow lost by the salary sacrifice arrangement.
I am here to tell you that this is in fact, just the combination of two completely separate strategies. One that is purely designed to reduce tax and build up wealth in a low tax environment. And another, which is designed to increase cash flow and allow the reduction of working hours in the lead up to retirement. Two strategies that, in reality, having nothing to do with one another.
In the good old days (pre 1 July 2017), strategy 1 (salary sacrifice) previously had some linkage to strategy 2 (TTR pension) because the TTR pension enjoyed tax free earnings. Nowadays, this link is gone.
Salary Sacrifice, the practice of pushing a greater amount of your pre-tax salary into super, is solely a tax minimising strategy that involves the swapping of your personal marginal tax rate, for the superannuation tax rate of 15%.
For example, the individual who earns $100,000 per annum that sacrifices another $10,000 of pre-tax salary would be giving up $6,100 of personal cash flow, essentially what $10,000 looks like after the tax man takes his share at the top marginal tax rate (MTR).
In the superannuation fund, this $10,000 salary sacrifice results in an after-tax increase of $8,500 of that same person’s super balance. A net benefit of $2,400 or, the difference in MTR and the concessional rate on the amount of salary sacrificed.
- Reduction in personal cash flow of $6,100
- Increase in super of $8,500
- Net benefit of $2,400
Transition to Retirement (TTR) Income Stream
A TTR, or more appropriately known as a non-commutable account-based pension, is one that can be commenced once you reach your preservation age. The main purpose of these income streams is to allow someone to reduce their works hours in the years leading up to full retirement.
Now, assuming this same individual comes to realise that their personal cash flow is now a bit tight, they may decide to commence a TTR pension to free things up a bit. Let’s assume, for simplicity, that they move $250k into the TTR and draw down their minimum pension of 4%. All of a sudden, we have $10,000 of pension income that is going to attract tax at the rate of the marginal tax rate less a 15% offset. In other words, 39% less 15%, or 24% to make it easy. Low and behold, he/she will pay $2,400 of tax on this new income.
Firstly, before 1 July 2017, there would have been tax saved inside of the pension as the earnings would have been taxed at 0%. In that world, the above-conjoined strategy made sense. In today’s world, it does not.
- Reduction in super of $10,000
- Increase in personal cash flow of $7,600
- Net loss of $2,400
The net effect of the two strategies running in tandem here is nothing. The reason being, with salary sacrifice, your tax savings is the difference between your MTR and 15%. With the TTR pension income, your additional tax paid is, you guessed it, the difference between your MTR and 15%.
Now salary sacrifice can make all the sense in the world if you have a cash surplus and you want to reduce overall tax. It does not make as much sense if cash flow is tight and you can only do it if you draw down on a TTR pension.
In the same breath, a TTR pension can make all the sense in the world if you need to supplement your personal cash flow. Just be aware, it is NOT a tax-saving strategy, it is a strategy that costs you tax.
Both can be great; they are just not related. You can either be suited towards none, either or both.
Before embarking on either of these, run the numbers and be sure it all checks out.