Making sense of a transition to retirement income stream

Pensions are an area of increasing regulatory focus for the ATO and it’s imperative SMSF trustees are across the existing, and potential, rules concerning a transition to retirement income stream (TRIS).

A TRIS is an account-based pension with some special features.

An account-based pension is a regular income stream paid from a superannuation fund. A separate account balance is maintained for each pension paid from the fund. The account balance increases or decreases with the earnings of the fund and is decreased by pension payments and any lump sum withdrawals. The pensioner is always required to take at least one payment in each financial year of at least a minimum amount. This minimum is set from the balance at commencement or as at 1 July if it is a continuing pension. The minimum payable under a TRIS is 4 per cent. A TRIS also has an annual maximum of 10 per cent.

Commencing a TRIS is an option in the period between when you reach your preservation age, (55 if that birthday was before 1 July 2015, moving on one year increases to 60 at 1 July 2024 for those born 1 July 1964 or later) and retirement or reaching age 65.

By removing the need to retire to access an income stream, the TRIS policy was designed to encourage people to stay engaged in employment after they reached preservation age. In practice, these income streams became usual planning practice for people with significant balances after the age of 60 because of the tax advantages for the fund and the member. They are now becoming more common before age 60.

The way a TRIS or other account-based pension works is that the member requests the fund to commence the pension. The balance of the member is calculated as at the date agreed for commencement of the pension. The minimums of all account-based pensions and the maximum for a TRIS are set from this commencement balance. The minimum will be adjusted to account for the period of time remaining in the year but the TRIS maximum is always 10 per cent of the commencement balance. This is reset at 1 July each year that the pension is in place.

You should obtain advice prior to commencing such a product as the fund rules, your balance and your other assessable income could affect the outcome. Some fund rules may not allow such a pension and some funds will charge fees that need to be considered as part of your decision.

A major advantage of commencing such a product is that the fund will stop paying income tax on the proportion of its taxable income that relate to the pension account (unsegregated method) or in some cases the income from the specific assets set aside as the assets to fund the pension (segregated method). This should assist your account balance as income will not be taxed.

Technical issues

Payments from a TRIS are subject to the same taxation rules as other account based pension payments. What is different is that you are not retired so you will usually have other assessable income from continuing employment or activity.

Taxation outcomes are dependent on a number of factors. Firstly, if you are over 60 when the TRIS payment is made, it will not be taxed. Secondly, to the extent that your balance at commencement is a tax-free component, it will not be taxed. Thirdly, taxation rules vary depending on whether the TRIS payment is to be taxed as a lump sum or income stream benefit.

Before the age of 60 some payments will be assessable income but where a payment is taxable as an income stream benefit it will come with an entitlement to a 15 per cent offset to reduce that tax.

Taxation of the payment as a lump sum is possible where the payment made to the member is the subject of an election by the member before it is made or where the member has an unrestricted component in their balance and asks for a partial commutation of their pension. The taxable component of any lump sum will be assessable income but taxed at 0 per cent up to the amount of the lifetime low rate cap, which is currently $195,000.

Once the lifetime cap is used, where lump sums are assessable income they are taxed at 15 pet cent (plus medicare levy depending on income tests). This may also affect other entitlements.

As this is a relatively new strategy your fund may not yet offer the option of making a lump sum election. Note that the ATO have advised that the election is effective for regulatory purposes but that it cannot be paid by an in-specie transfer of assets. They have also said that it may affect the exempt current pension income of the fund. The expected impact on the fund is that the election may affect whether assets supporting the pension are regarded as segregated. In our experience, SMSFs paying a TRIS are usually operating on the unsegregated method because of the continuing flow of contributions from the ongoing activity.

Commutation to a lump sum is not usually an option simply because most people who are yet to retire don’t have any unrestricted component in the account. If it is an option, that amount will count for the minimum but not the maximum.

If an election is made that a payment be taxed as a lump sum, the payment will count for both the minimum and the maximum.

The other critical calculation is the tax-free proportion. If an account-based pension is paid entirely from a balance that is non-concessional contributions or other tax-free amounts then the tax-free proportion is 100 per cent. This can affect taxation not only of the payments before age 60 but of the balance if it is inherited. For that reason if you are planning to make a contribution and then commence a pension, you should obtain advice before the contribution is made. Once a contribution is made to an account, it will mix with the existing balance of that account.

Conclusion

Some commentators are suggesting that the option to commence such a product may be removed in the 2016 budget. If that happens it is almost certain pension products that are already in place will be allowed to continue. It is always best to ensure all pension products are well documented. If you are concerned about a possible change in rules, you might also request the minimum payment be made before budget 2016, especially where you are electing that it be taxed as a lump sum. If TRIS pensioners are making the lump sum election, it needs to be made before the payment.

Stuart Forsyth, director, McPherson Super Consulting 

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