How to transition to retirement

Rather than retiring outright, many people prefer to partially retire or reduce work commitments in the months or even years before they fully retire.

If you’ve reached your super preservation age (between 55 and 60 depending on your date of birth) and you’re not ready to retire, you can start to look at tax-effective transition to retirement (TTR) strategies that let you start drawing down your super even while you’re still working.

This means that you may reduce the number of hours you work or increase your super contributions in the lead up to retirement – and have the chance to minimise your tax along the way.
 
You can choose to take advantage of a TTR strategy in one of two ways:

Want to know more about when you can access your super? Let's go.

Let’s take a closer look at how these TTR strategies work and see how people like you have used them in the run up to retirement.

Strategy one

Tax focus: work full time and grow your super:

This option involves salary sacrificing some of your before-tax income to super. These contributions don’t attract income tax and are instead taxed in the fund at just 15%, meaning you reduce the amount of income tax payable on your salary and wage income.

Meanwhile, you can draw a TTR pension from your super to make up for the drop in your take-home pay. In most cases, you’ll pay less tax on your pension income than you would on the same amount of salary or wages.

If you get the balance right between what you’re putting into super and what you’re taking out, you could increase your super balance while you maintain the same or a similar level of income.

Keep in mind:

  • There are annual limits to the amount you can salary sacrifice, called concessional contribution caps. Exceeding these caps attracts a significantly higher rate of tax, so it’s important to keep track of your contributions

Need to know more about the super contribution caps? Let’s go.

  • The annual TTR pension you draw must be between 4% and 10% of the pension account balance
  • You won’t be able to access your super as a lump sum while you are drawing a TTR pension.

Judy, 55, earns an annual salary of $50,000 and has accumulated $300,000 in super. She loves her job and wants to keep working until she’s 65.

If Judy doesn’t use a TTR strategy:

Over 10 years, her salary remains at $50,000 per year and her after-tax income rounded to the nearest hundred dollars at $41,453. 1 Due to investment earnings* on her super and the Super Guarantee (SG) contributions paid by her employer, by age 65 her retirement savings would be:

Retirement balance at 65

$495,416

Minimum pension on this balance

$24,770

If Judy uses a TTR strategy:

Judy’s TTR allocated pension gives her a 15% pension tax offset that her salary income doesn’t. She can then sacrifice part of her salary to super, which can be used to make up for the reduction in her retirement savings from the pension payments.

Judy’s after-tax income remains unchanged:

Salary

$50,000

Salary sacrifice

$14,813

Minimum pension payment

$12,000

Income tax and Medicare

$7,534

15% pension tax offset

$1,800

Net income (rounded to the nearest hundred dollars)

$41,453

Judy’s retirement savings are then helped by her salary sacrifice contributions and the fact that her fund taxes her investment earnings at a maximum rate of 15%. In fact, she can increase her retirement balance at age 65 by over $45,000 and her potential minimum payment at that time by over $2,200 each year:

Retirement balance* at 65

$540,850

Mimimum pension on this balance

$27,040

Summary:

Option

Retirement balance* at 65

Minimum pension on that balance

Work full-time until 65 and make no extra super contributions

$495,416

$24,770

Work full-time until 65 and part salary sacrifice. Supplement income with a TTR pension.

$540,850

$27,040

Strategy two

Lifestyle focus: reduce your working hours but not your take-home pay

If you want to ease into retirement but are concerned about the drop in pay, you can supplement your lost income with payments from your TTR pension. This would give you more time to do the things you want without compromising your lifestyle.

Another benefit is that you’ll still be getting Super Guarantee (SG) contributions from your employer.

Keep in mind:

  • You run the risk of drawing down your super too early, so it’s important to plan your transition to retirement carefully. It’s also a good idea to seek professional financial advice about whether you can afford to start drawing on your super before you fully retire
  • There is a minimum (4%) and maximum (10%) limit to the amount you can draw from your pension account balance via a TTR pension
  • You won’t be able to access your super as a lump sum while you are drawing a TTR pension.

David, 55, earns an annual salary of $50,000 and has accumulated $300,000 in super. He’d like more time to pursue his hobbies and be with his grandchildren. On the other hand, he enjoys his work and the salary it brings.

The question is whether he has enough money now to retire and maintain his after-tax yearly income of $41,453 or if he can reduce his working hours and use a TTR pension to supplement his part-time salary.

If David retires immediately:

His net income after receiving his pension payment would be:

Pension payment

$42,299

Income tax and Medicare

$5,774

15% pension tax offset

$6,345

Net income (rounded to the nearest hundred dollars)

$41,453

Note: David’s income tax and Medicare includes tax offsets which, with the 15% pension tax offset, mean David’s only tax liability is for a Medicare levy of $846.

To maintain an after-tax income of $41,453, David needs to draw a pension payment of $42,299. This is 14% of his pension account balance. If he continues to draw a pension payment at this rate, he will have exhausted his pension account by age 63.

If David uses a TTR strategy:

He works part time and receives a salary of $30,000 per year, which he can then supplement with a payment from a TTR allocated pension:

Salary

$30,000

Pension payment

$16,203

Income tax and Medicare

$7,180

15% pension tax offset

$2,430

Net income (rounded to the nearest hundred dollars)

$41,453

Summary:

Option

Retirement balance* at 65

Minimum pension on that balance

Retires immediately at 55

NIL

NIL

Works part-time until 65. Income supplemented by pre-retirement pension.

$338,410

$16,920

A financial planner can help you weigh up the benefits and limitations of each TTR strategy before you decide if one is right for you.

*Assumptions: Earning 7.7% pa after fees and before taxes with inflation at 3%. Using 2014-15 income tax rates. Pension is paid as an account-based pension. Superannuation guarantee contributions are 9.5% of gross salary in year 1, increasing to 12% by year 7, before any salary sacrifice. All superannuation contributions and pension payments are made regularly throughout the year. Income Tax and Medicare figures take into account the Low Income Tax Offset (LITO).  A change to any of the assumptions and variables can provide significantly different results. These case studies are for illustrative purposes only. Your individual circumstances have not been taken into account.

1 Assumption uses 2014-15 tax rates for the next 10 years.

Things to know before you Can:

This document contains general advice only. It does not take account of your individual objectives, financial situation or needs. You should consider talking to a financial planner before making a financial decision.

Taxation considerations are general and based on present taxation laws and may be subject to change. You should seek independent, professional tax advice before making any decision based on this information.

While care has been taken in the preparation of this document, no liability is accepted by Commonwealth Financial Planning, ABN 65 003 900 169, AFSL 231139, its related entities, agents and employees for any loss arising from reliance on this document.