With transition to retirement (TTR) income streams set to lose their tax-free earning status from 1 July 2017, it is appropriate to contemplate the implications of this change for existing TTR clients and those considering implementation of a TTR income stream.
Earnings on TTR investments will no longer be exempt from tax
Irrespective of a TTR income stream’s commencement date, investment earnings will be subject to tax of up to 15% from 1 July 2017. The effect of this increased tax is a reduced tax benefit (arguably in some cases marginally) for TTR income streams.
Where a client meets a superannuation condition of release (such as retirement after preservation age, terminal medical condition, permanent incapacity or attaining age 65) it will generally be possible to transfer the TTR income stream into a retirement phase income stream with tax-free earnings.
Note: On 15 June 2017 legislation (Treasury laws Amendment (2017 Measures No.2) Bill 2017) was passed by both Houses of Parliament to allow a TTR income stream to be treated as a retirement phase income stream (with tax-free earnings) automatically from when the member attains age 65 or when the member notifies the income stream provider that they have satisfied a relevant condition of release (retirement after preservation age, terminal medical condition or permanent incapacity). This Bill has received Royal Assent.
TTR income streams will not count towards a client’s transfer balance cap
As TTR income stream earnings are taxable from 1 July 2017 they are no longer treated as retirement phase income streams.
Importantly, only income streams which are in the retirement phase will count towards a client’s transfer balance cap (TBC).
Where a TTR income stream becomes a retirement phase income stream it will then count towards a client’s TBC.
Taxation of TTR payments received remain unchanged
Although the taxation of TTR earnings is changing, the taxation of payments to a member is not. For members aged 60 or over, payments continue to be 100% non- assessable non-exempt income. For members between preservation age and age 60, the taxable component of payments continue to be taxed at their marginal tax rate with a 15% tax offset, with any tax-free amount continuing to be non-assessable non-exempt income.
The tax benefit of combination TTR and concessional contribution strategies has reduced
As described, the tax benefit of TTR income streams is reduced by the increased tax on investment earnings. Many TTR income streams implemented in combination with concessional superannuation contribution strategies effectively allowed a client to replace taxable income from employment with concessionally taxed income from a TTR income stream.
For many clients this strategy will continue to provide a tax benefit, though at a reduced rate from 1 July 2017.
Reduced $25,000 concessional contribution cap may affect the strategy benefit
In a number of cases, implementing a TTR strategy has allowed a member to salary sacrifice more to superannuation. In cases where the amount being sacrificed will cause the member to exceed their concessional contribution cap (reduced to $25,000 from 1 July 2017), the amount that can be contributed before-tax is reduced.
In some cases it could be worth considering reducing the payment received to the minimum (if possible), before 1 July 2017 partially commute the income stream to superannuation in order to reduce the minimum payment amount and/or maintain the higher payment increasing the amount assessed for tax at the member’s marginal tax rate.
TTR is still available to help clients transition to retirement
Despite this change to the taxation of TTR income stream earnings, TTR income streams remain a valuable strategy. Their utilisation continues to support clients transitioning from full time employment to retirement over time by supplementing employment income via superannuation savings where a condition of release has not yet been met.
Tax-free and taxable components continue to be proportionally fixed
Although the TTR earnings will no longer be tax-free, a TTR income stream remains an income stream. This means the tax-free and taxable proportions continue to be fixed based on the tax-free and taxable amount used to commence the TTR income stream.
Tax exempt earnings may still be available
In the event a member has met a condition of release before 1 July 2017, consideration should be given to whether the TTR income stream will be considered a retirement phase income stream, in which case no tax will be payable on the earnings and the withdrawal benefit at 30 June 2017 will count towards the member’s TBC. This will occur automatically for member’s aged 65 at 1 July 2017. For other conditions of release the TTR income stream will be a retirement phase income stream from the time the member notifies the trustee they have met a relevant condition of release.