One of the big challenges we at Argentis face at the moment is to explain and advise our clients on the massive changes to superannuation, particularly for those of you who are older than 45.
The government is restricting the level of contributions into superannuation and have introduced a ‘Non-Concessional Contributions’ limit or cap (NCC cap) and a ‘Concessional Contributions’ limit or cap (CC cap). The NCC cap basically applies to contributions that you do not claim a tax deduction for and the CC cap basically applies to contributions that you do claim a tax deduction for.
The NCC cap is $150,000 per person for the 2007/2008 income year.  This cap is set each income year at three times the CC cap which is indexed annually to AWOTE movements in increments of $5,000 ie. 3 x $50,000 = $150,000.
An effective 3 year NCC cap allows you to ‘bring forward’ 2 years worth of non-concessional contributions without exceeding the cap. This bring forward is automatically triggered when you make contributions in excess of the NCC cap in a financial year in which you were under age 65 at any time (and a bring forward had not already commenced in the previous two financial years).
To simplify the operations of the NCC cap, people aged 63 and 64 can take advantage of the bring forward without the need to satisfy a work test that would ordinarily apply upon turning age 65.
The CC cap is $50,000 per person for the 2007/2008 income year.  This cap is indexed annually to AWOTE movements in increments of $5,000. A transitional CC cap of $100,000 applies from 2007/08 to 2011/12 for people aged 50 or over at any time in an income year during the transitional period.  This transitional cap is not indexed.
In the case of self-employed people, they can contribute up to $50,000 pa in tax-deductible form without triggering adverse tax consequences.  Under transitional rules the amount for those aged 50 and over is $100,000 until 30 June 2012. Note that a self-employed person cannot create a tax loss with a deductible superannuation contribution.
Amounts over the $50,000 (or $100,000) will become excess concessional contributions and will attract tax at 31.5%. The contribution will be assessable in the fund. Thus, while there is no rule which specifically limits the amount that is claimed as a tax deduction (apart from the tax loss constraint), the combination of rules effectively mean that $50,000 (or $100,000) is the practical limit for self-employed people.
There is no rule which prevents an employer from claiming a deduction for amounts in excess of the $50,000 (or $100,000) cap for contributions made in respect of an employee, however, because of the additional tax applicable to excess concessional contributions, most employers will not claim a deduction in excess of the relevant cap amount because of the consequences that would have for the employee.
For those of you who have already reached age 55 and are still working there is even further change and complexity on how you should consider managing your financial affairs in the ‘new world’ of superannuation (post 30 June 2007). These changes don’t just impact your superannuation as there is a flow on effect to your entire financial planning.

When you contribute money into superannuation it goes into what we call the ‘accumulation phase’ and once you start drawing down on your superannuation in the form of a regular income you go into what we call the ‘pension phase’. Any earnings in your superannuation fund within the accumulation phase are taxed at 15% and two thirds of capital gains are taxed at 15%, whilst all earnings and capital gains within the pension phase are TAX FREE.

The superannuation changes have many implications for Transition To Retirement (TTR) pensions, particularly the new payment levels, changes to the taxation treatment of payments and when you can gain access to your superannuation funds. The preservation status of money in a superannuation fund indicates what you can do with it and when. There are three classes of preservation:

Preserved benefits have to stay in your superannuation until you meet a condition of release.

Restricted non-preserved benefits generally also must remain in the fund until you meet a condition of release. If you are wondering what is the difference between this and a preserved benefit, these benefits have slightly different release rules.

You can access Unrestricted non-preserved benefits right now and draw them out of your superannuation as cash if you really want to. People who have had superannuation in place for many years may have some unpreserved money, though no new unrestricted non-preserved components have been created for a while now.

For many people TTR pensions will be even more attractive in the ‘new world’ and we have included some analysis below.

New payment factors

From 1 July 2007 all new account-based pensions (including new TTR pensions) will be subject to new
minimum payment factors. Superannuation fund trustees may elect to apply the new minimum payment factors to allocated pensions (including TTR APs) already running prior to 1 July 2007.

The new factors mean those aged 55 -64 will be required to draw at least 4% of their account balance
per annum. With the removal of the maximum withdrawal limitation for non-TTR allocated and
account-based pensions, TTR pensions commenced on or after 1 July 2007 (and those commenced prior to 1 July 2007 adopting the new minimum payment factors) will be subject to a maximum withdrawal limit of 10% p.a.

Chart 1: Compares the old and new factors, showing the increased flexibility of the new factors.

Taxation of TTR pension payments

Given the changes to the taxation of pension payments in general, TTR pensions will also have two distinct periods of taxation: pre age 60 and post age 60. During the pre age 60 period pension payments are prima facie assessable income, with a 15 % tax offset applying. Any tax-free component in the purchase price will result in a fixed percentage of every payment being non-assessable, non-exempt income, reducing the level of otherwise assessable income.

During the post age 60 period all payments will be non-assessable, non-exempt income.

Once a condition of release (such as retirement) is met a TTR pension may simply continue to run as an ordinary allocated or account-based pension (ABP), with the maximum payment restriction simply dropping away. Hence there is no need to commute the TTR pension and purchase a new ABP with the proceeds. However, commutation and recommencement may be preferred, for example, where the client wishes to add more capital and/or combine existing pensions to run one ABP account.

Treatment of unrestricted non-preserved monies within a TTR pension

The general purpose of a TTR pension is to allow access to preserved and restricted non-preserved benefits which you wouldn’t otherwise have. But in some cases taxation efficiency might rank at least as highly as access to the benefits. Either way, understanding how the preservation rules work with TTR pensions is important.

Example:
Mark is aged 55 and has a superannuation fund balance of $500,000. He is considering starting a
TTR pension. $50,000 is unrestricted non-preserved, the remaining amount preserved. If Mark starts a TTR pension with any of the existing funds, the first $50,000 will be deemed to have been taken from the unrestricted non-preserved element. If Mark starts the TTR pension with the entire $500,000, and draws the maximum 10% in the first year, at the end of year 1 his entire remaining benefit will be preserved.

Alternatively, Mark could roll over $50,000 to another fund and elect the whole amount rolled over is unrestricted non-preserved element. Starting a TTR pension with the balance and drawing the maximum $45,000 in the first year, plus $5,000 as a lump sum from his accumulation fund, would leave $45,000 unrestricted non-preserved benefits remaining, which Mark could access at a later date.

Accumulation or pension phase – which is more effective?

Example:
Anne is aged 55 and is interested in maximising her retirement funding. After some significant contributions in recent years she currently has approximately $600,000 accumulated in superannuation. Let’s assume that Anne is unable to salary sacrifice any more than she currently is, for any one of a few possible reasons. Looking at the $600,000 in isolation, should Anne commence a TTR pension, or leave the funds in the accumulation phase?

If the funds are left in accumulation phase they will accrue returns in a 15% taxation environment. Furthermore if the assets are held until the funds are transferred into pension phase, they could be effectively CGT-free. So for a given set of return assumptions the net effective tax rate in the accumulation phase will vary depending on the asset turnover rate/strategy.

On the other hand, if the funds are transferred to a TTR pension they will accrue returns in a tax-free
environment. There will, however, be some taxation implications prior to Anne’s 60th birthday on the
minimum (4%) pension payments she is required to draw. Let’s assume these pension payments
are reinvested (after payment of income tax) into a separate accumulation superannuation account as
NCC’s within Anne’s NCC cap. We can then calculate the net effective tax rate (including the income tax paid) effectively applicable to total fund earnings, including the taxation on the returns in accumulation account where the NCC’s are re-invested. We can then compare the tax paid in each strategy in terms of the net effective tax rate.

We have calculated the net effective tax rate for the periods from age 55 -59 and 60-64 inclusive for each strategy, i.e. remaining in accumulation phase or switching to a TTR pension (with 100% tax-free component, 50% tax-free or 0% tax-free components in the TTR pension purchase price). Within each TTR pension scenario we have varied Anne’s marginal tax rate. The results, along with the account balances at age 60 and 65 are displayed in the following tables – each table represents a fixed level of asset turnover per annum (i.e. 0%, 30% and 100%).

This allows comparison of the net effective tax rate for ‘Accum Only’ strategy (silver shading) against the
‘TTR + Accum’ strategy. The ‘TTR + Accum’ result is shaded blue where it produces a better result than
the equivalent ‘Accum Only’ strategy. Otherwise it is shaded black.

Table 1: Net effective tax rate – 0% asset turnover (i.e. hold capital assets until pension phase)

Table 2: Net effective tax rate – 30% asset turnover (i.e. capital assets are held for 31⁄3 years)

Table 3: Net effective tax rate – 100% asset turnover (i.e. capital assets are held for less than 12 months)

Some key points to note from these results:

Are you confused yet? Who said this is “Simpler Super”?

Conclusion

The results indicate that in general a TTR pension is a valid strategy for most people. However, careful analysis and modelling is required to determine whether people on the top MTR should use a TTR pension before age 60. Sometimes these people may benefit from remaining in the accumulation phase until age 60 and commencing a TTR pension from that point.

The 2007 reform of the superannuation system has improved the relative attractiveness of TTR pensions. Pension payment levels are more flexible and changes to the taxation of superannuation
income streams have positive effects, especially after age 60. Upon meeting a subsequent condition of release like retirement, a TTR pension will automatically transform to an ordinary ABP. Care should be taken to use only preserved benefits when purchasing a TTR pension if maximum access to capital is a priority.

Broadly the TTR pension appears to be a very attractive vehicle to help maximise retirement benefits – we expect a high percentage of clients aged 55 -64 will benefit from a TTR strategy.

We would particularly like to thank Macquarie Adviser Services for assistance with this article.