The transition to retirement condition of release allows superannuation fund members who have reached preservation age (but have not ‘retired’ for superannuation purposes) to commence an income stream using their preserved benefits.

This type of income stream has several limitations and is often referred to as a transition to retirement income stream (TRIS). In this article, we aim to address some of the strategic applications of commencing a TRIS.

There are various reasons why a person may choose to commence a TRIS:

• to meet expenses and manage cash flow, including lifestyle/leisure, reducing work hours;
• use income payments to make spouse contributions to equalise account balances;
• unlock cash flow to make extra concessional contributions (i.e. income swap strategy); or
• undertake a gradual re-contribution strategy for estate planning purposes.

Of course, a TRIS no longer receives a tax exemption on income from its supporting assets, somewhat reducing the tax effectiveness of TRIS-based strategies. That is, the income (including realised capital gains) from assets supporting a TRIS is effectively taxed in the same way as super accumulation interests at a maximum of 15 per cent.

That said, income payments from a TRIS to a member are completely tax-free once the member reaches age 60.

Note: When considering these opportunities, remember that income payments from a TRIS for a person under age 60, to the extent they contain taxable component, are taxed at the member’s marginal tax rate less a 15 per cent tax offset.

Strategy 1: Meet expenses and manage cash flow

Consistent with the original policy intent, where a person reduces their working hours (and corresponding income levels), a TRIS provides access to up to 10 per cent of their accumulated super each financial year to maintain their required cashflow.

Similarly, some people may choose to use a TRIS for lifestyle expenditure – for example, funding extensive travel prior to retirement. While others may use a TRIS to assist with debt reduction or simply to supplement lifestyle expenses.

Strategy 2: Use income payments to make spouse contributions to equalise account balances

This strategy may assist a couple where one spouse is close to or over the $1.6 million transfer balance cap, and the other spouse has considerably less in super. Where the person with the higher level of accumulated super commences a TRIS, the net income payments can be re-contributed (within relevant contribution caps) into the account of the person with the lower balance.

Equalising spouse account balances is not limited to those who have close to or over $1.6 million in super. It is also useful in managing a client’s total superannuation balance (TSB), which is measured at each 30 June and is relevant to the following:

• manage a client’s TSB to less than a $1.4, $1.5 or $1.6 million threshold to maximise or enable non-concessional contributions (NCCs) in the immediate following year;
• manage a client’s TSB to less than $500,000 to enable use of catch-up concessional contributions (CCs) in the following financial year; and
• manage a client’s TSB to less than $300,000 to enable use of the ‘work test exemption for recent retirees’ in the following year.

If the contributions are made as spouse contributions, the spouse contribution tax offset might also be available where the receiving spouse has income less than $40,000 per annum.

Furthermore, where one member of the couple is undertaking a TRIS income swap strategy (see below), up to 85 per cent of the concessional contributions made into their account can be split with the other spouse. This allows the spouse with the higher balance to take advantage of the tax benefits of the TRIS income swap strategy, with the concessional contributions made as part of this strategy being essentially accumulated in their spouse’s account with the lower balance.

Strategy 3: Income swap strategy

Using the ‘income swap’ strategy to unlock cash flow to make extra CCs into super (provided there is cap space available) can be an effective way to increase retirement benefits.

Despite the 15 per cent tax on earnings from assets supporting a TRIS, and the lower CCs cap of $25,000 per annum, the income swap strategy can still be used to boost retirement savings, albeit at a lesser rate than could be achieved before 1 July 2017.

This strategy is used to unlock cash flow, which is then used to make additional CCs. It involves a person increasing their salary sacrifice (or personal deductible) contributions and supplementing their forgone income with income payments from the TRIS.

TRIS income swap strategy considerations

The benefit of the TRIS income swap strategy depends on the individual circumstances of the client. The below factors can impact the effectiveness of the strategy:

• The age of the client;
• The client’s income level(s);
• The size of accumulation balances;
• Whether the client is employed or self-employed;
• The tax-free percentage within the TRIS (mainly for clients under age 60);
• A client’s total superannuation balance;
• Whether the client is single or a member of a couple; and
• Concessional contributions cap and whether the client is able to apply unused carried forward concessional contributions from a previous financial year.

Pension refresh

A pension ‘refresh’ or ‘re-cast’ involves the following steps:

• commuting the existing TRIS and transferring it into the accumulation account; and
• using the combined amount to commence a new TRIS.

There are several reasons why a pension refresh might be undertaken.

First, if the TRIS income swap strategy is implemented at say, age 60, then generally by age 65, the accumulation account will have increased. The pension account will have remained static or even reduced – of course, much depends on variables such as the level of pension drawn, amount of CCs made, earning rates and fees and charges.

In some circumstances, a TRIS income swap strategy can be enhanced by periodically ‘refreshing’ the strategy. The pension refresh strategy may allow a higher level of CCs to be made into the accumulation account, as the new and increased TRIS can pay a larger (up to 10 per cent per annum of the account balance) tax-free or tax efficient replacement income.

Where suitable, a refresh strategy may accelerate the benefits of the TRIS income swap strategy for members with smaller superannuation balances or lower levels of income. It may also be of benefit where a person is re-contributing NCCs for estate planning purposes (see later).

Case study

Ben, age 58, is a full-time employee on a salary of $95,000 per annum.

His employer currently pays 9.5 per cent per annum SG (i.e. $9,025 pa). Ben’s super balance is $400,000 – all taxable component and preserved. Ben has unused carry forward CCs cap from the 2018-19 and 2019-20 financial years of $30,000.

Ben does not have any surplus cash flow to make any further additional super contributions, as his living expenses fully consume his net take-home pay.

Ben is eligible to commence a TRIS, as he has reached preservation age. If he uses his entire $400,000 super balance to commence a TRIS, Ben must draw at least the minimum of $8,000 per annum (2 per cent) and not more than the maximum of $40,000 per annum (10 per cent).

Ben’s SG contributions are $9,025 per annum, leaving him with $15,975 per annum on his 2020-21 financial year standard CCs cap.

He also has $30,000 unused CCs cap space carried forward from the 2018-19 and 2019-20 financial years. He can apply this unused CCs cap amount in financial year 2020-21 because his TSB on 30 June 2020 was less than $500,000. Therefore, Ben can make up to $55,975 in total CCs for financial year 2020-21 without breaching his CCs cap.

The tables below shows the result of an income swap strategy using Ben’s entire accumulated balance ($400,000) and applying the $30,000 of unused CCs cap in the first year of the strategy over the period to his 65^th birthday.

Net contributions into superannuation

	Current Age 58	Year 1 Age 58	Year 2 Age 59	Year 3 Age 60	Year 4 Age 61
Salary sacrifice contributions	0	45,923	15,795	15,610	15,423
SG contributions	9,025	9,025	9,206	9,390	9,577
After tax (NCCs)	0	0	1,876	5,204	5,116
Contributions tax	1,354	8,242	3,750	3,750	3,750
Net contributions	7,671	46,706	23,126	26,454	26,366
TRIS pension payments	0	36,900	15,119	15,092	15,423
Net into super	7,671	9,806	8,007	11,362	11,301
Net into super (do nothing)		7,671	7,825	7,981	8,141
Benefit of TRIS income swap strategy (pa)		+2,135	+182	+3,381	+3,160
TRIS plus accumulation balance
Balance at end of year (no income swap strategy)		423,421	447,912	473,854	500,774
Balance at end of year (income swap strategy)		425,597	450,358	479,506	509,729
Cumulative benefit of TRIS		2,176	2,446	5,652	8,955

 

	Year 5 Age 62	Year 6 Age 63	Year 7 Age 64	Year 8 Age 65
Salary sacrifice contributions	17,217	16,487	15,732	14,951
SG contributions	10,283	11,013	11,768	12,549
After tax (NCCs)	4,743	5,073	5,416	9,515
Contributions tax	4,125	4,125	4,125	4,125
Net contributions	28,118	28,448	28,791	32,890
TRIS pension payments	15,039	15,012	15,732	18,698
Net into super	13,079	13,436	13,806	14,192
Net into super (do nothing)	8,741	9,361	10,003	10,667
Benefit of TRIS income swap strategy (pa)	+4,338	+4,075	+3,803	+3,525
TRIS and accumulation balance
Balance at end of year (no income swap strategy)	530,608	562,042	595,165	630,067
Balance at end of year (income swap strategy)	542,942	577,815	614,425	655,175
Cumulative benefit of TRIS	12,335	15,772	19,260	25,108

 

In many cases, the benefit of a TRIS income swap strategy when a client is under age 60 is minimal (at best). However, there are two situations where the strategy could be considered.

First, when the client has unused carry forward CCs cap that can be applied (as per Ben’s case).

The unused CCs increase Ben’s cap in the first year to $55,000 meaning that Ben has an increased ability to swap taxable salary for tax concessional salary sacrifice contributions and TRIS income. Therefore, the net contributions into super in the first year ($9,806) are much higher than the second year ($8,007). In the second year where there is no unused CCs cap available and Ben is still under age 60 and the TRIS income payments are taxable, the net contributions into super significantly reduce and are only slightly more than if Ben didn’t undertake the income swap strategy.

The second situation where the TRIS income swap strategy may be worthwhile for a client under age 60 is where tax-free component exists within the TRIS. This is because less tax is paid on the income payments (i.e. nil tax on the tax-free proportion of the income payments), resulting in a lower income payment required to keep net income the same, thus improving net contributions into super.

For example, if 25 per cent of Ben’s balance was tax-free component (i.e. $100,000), the net contributions into super in year two would increase from $8,007 to $9,010. The higher the tax-free proportion of the TRIS balance when the person is under age 60, the better the outcome of the TRIS strategy.

After-tax (non-concessional) contributions

Ben is required to draw at least the minimum income from the TRIS. His CCs cap limits the amount that can be contributed to super on a pre-tax basis, resulting in surplus cash flow. This surplus is redirected to superannuation as an NCC.

If Ben doesn’t want to make any additional NCCs, he could reduce the amount used to commence his TRIS. Regardless of whether the funds are in accumulation phase or in a TRIS, the earnings will be taxed at a maximum of 15 per cent.

Alternatively, Ben could draw out any amount up to the maximum. The greater the TRIS income Ben draws, the larger the NCCs that can be re-contributed. Re-contributing this amount as an NCC allows Ben to convert ‘taxable’ component into ‘tax-free’ component. Whilst not of benefit to him directly, increasing tax-free component is beneficial where the proceeds will be paid to a non-tax dependant upon death.

Strategy 4: Gradual re-contribution strategy for estate planning purposes

Clients with non-dependant beneficiaries may benefit from commencing a TRIS to implement a gradual re-contribution strategy. A re-contribution strategy allows taxable component to be converted into tax-free component over time. Tax-free component is paid completely tax-free upon death, regardless of which class of beneficiary receives it.

This strategy requires that a client has NCCs cap space available each year and they use the net income payment from the TRIS to make a NCC into their super account. At the commencement of the next financial year, the TRIS can be ‘refreshed/recast’ (i.e. commuted back to accumulation phase) and either a new TRIS (now with a higher tax-free component) or a new 100 per cent tax-free component TRIS commenced.

This process can be repeated over several years to increase the level of tax-free percentage in the TRIS (or in an accumulation account). This will be an effective strategy for those who are age 60 and over, as the TRIS income payments are tax-free.

Concluding thoughts

Notwithstanding the loss of the tax exemption on income from its supporting assets, and the reduced tax effectiveness of TRIS-based strategies, there are still plenty of reasons left to consider the benefits of commencing a TRIS.

John Perri, Technical Strategy Manager, AMP Australia.

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Assumptions used for Ben case study

The following assumptions have been used in this case study:

50 per cent growth investor (gross investment return of 4.54% p.a., after-tax investment return of 3.90% p.a.);

contributions and pension drawdowns assumed to be made in the middle of the year;

concessional contributions can be made as either salary sacrifice (where the employer allows) or as personal deductible contributions;

salary and living expenses indexed at 2% p.a.;

SG rate rises from 9.5% to 12% as legislated;

where SG is payable, the employer will continue to pay the SG rate on the employee’s pre-salary sacrifice salary;

concessional contributions cap is indexed in $2,500 increments based on AWOTE of 2% p.a.;

unused concessional contributions of $30,000 from the 2018-19 and 2019-20 financial years are applied in the first year of the strategy; and

product and/or advice fees are not included.

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QUESTIONS

To answer the following questions, go to the Learn tab at moneyandlife.com.au/professionals

1. Harry has decided to commence a TRIS, as he primarily wants to use income payments to make spouse contributions to equalise account balances. There are other reasons why he has also decided to commence a TRIS. However, which of the following statements is not a valid reason for Harry to commence a TRIS?

a. Harry requires extra income for lifestyle expenses.

b. Moving super accumulation assets to a TRIS will result in a tax exemption for investment earnings from assets backing the TRIS.

c. Harry requites extra income to maximise super contributions under an ‘income swap’ strategy.

d. Harry would like additional cash flow to be able to make additional NCCs for estate planning purposes.

2. Jane wants to increase her retirement benefits and is considering using the income swap strategy to unlock cash flow in order to make extra concessional contributions into super. Which of the following considerations are likely to have an impact on the effectiveness of a TRIS income swap strategy for Jane?

a. The amount of concessional contribution cap available to Jane.

b. The level of a Jane’s taxable income.

c. Jane’s age.

d. All of the above will impact on the effectiveness of a TRIS income swap strategy.

 

3. Which is correct? An ‘income swap’ strategy will be most effective for clients who:

1. Have a large ‘tax-free’ component in their TRIS.

2. Receive TRIS income payments from age 60 or over.

3. Otherwise have a significant unused concessional contributions cap within the year.

a. 1 is correct.

b. 2 is correct.

c. 3 is correct.

d. All of the above are correct.

 

4. A ‘refresh’ or ‘re-cast’ of a TRIS is useful to:

1. Make the TRIS account balance ‘unrestricted, non-preserved’.

2. Increase the account balance and consequently, the maximum income payment that can be drawn from the TRIS.

a. 1 is correct.

b. 2 is correct.

c. Both 1 and 2 are correct.

d. Neither 1 or 2 is correct.

 

5. The aim of the ‘income swap’ strategy is to maintain the client’s before and after implementation after-tax income at the same level, while maximising their concessional super contributions. True or false?

a. True

b. False