Superannuation is the most tax effective place for wealth to be invested in retirement, yet half of Australians in retail super funds are not taking advantage of the tax savings available to them.
Money invested in the superannuation environment pays tax at the concessionally low rate of 15% on earnings, contributions, and capital gains. This tax rate is then reduced to 0% once the member chooses to commence a tax-free pension account, representing a significant tax saving.
Eligibility
In order to commence a tax-free pension, a superannuation member must first meet a condition of release. The most common conditions are:
- Attaining age 65 (can be retired or still working)
- Ceasing an employment arrangement after age 60
Once a condition like this has been met, members can transfer up to $1.9 million of their superannuation savings from an accumulation account (paying 15% tax) to a pension account (paying 0% tax).
In 2021, approximately 619,000 older Australians (aged 65 and over) were employed in the labour force. However, in 2023, 49% of members in retail super funds over the age of 65 still had their entire balance in accumulation phase. You could assume a large portion of these people were still working and hence had no need to start drawing a pension. However, that’s a lot of unnecessary tax being paid! Self-Managed Super Fund (SMSF) members commonly receive more advice in this area, with only 12% of members over 65 still having their balance in accumulation phase.
Tax saving
To put some context around this tax saving opportunity.
A superannuation balance of $1.9 million invested in an accumulation account pays 15% tax, which if taxable earnings are around 5% p.a, equates to a tax bill of approximately $14,250 p.a. If the same balance of $1.9 million was invested in a tax-free pension account, the $14,250 effectively becomes an annual tax saving.
Similarly, a lower superannuation balance of $900,000 invested in an accumulation account paying 15% tax, with the same taxable earnings rate of 5% p.a, would be paying tax at around $6,750 p.a. If the same balance of $900,000 was invested in a tax-free pension account, the $6,750 effectively becomes an annual tax saving.
What’s the catch?
By definition, the word pension means a ‘regular payment’, so naturally a certain amount must be withdrawn from these tax-free pension accounts each year. The ATO stipulates the minimum pension requirements for each age group:
Minimum pension requirements for each age group:
These pension payments are received as tax-free income into the member’s bank account. They can be used to cover cost-of-living expenses in retirement or to supplement employment income if working hours are being reduced.
Don’t need the cash?
However, a proportion of people simply don’t need the cash. If this is the case, pension payments can be effectively reinvested once withdrawn; either back into superannuation (if certain requirements are met), in your own name, or into another investment structure. This is where good advice comes into play.
Pension payments can be reinvested back into superannuation as a non-concessional contribution if the member is under age 75 and has a total superannuation balance under $1.9m. It can also be reinvested back into super as a personally tax-deductible concessional contribution if the member is under age 67 or if they are under age 75 and meet a work-test. This is known as a pension-recontribution strategy.
So starting a pension isn’t just for people who need the cash.
These reinvestment options allow members to get the best of both worlds; significant tax savings from the tax-free pension account, plus the ongoing benefits of investment growth and earnings.
Emma Hicks is a financial adviser of HLB Mann Judd Wealth Management (NSW) Pty Ltd (AFSL 526052) ABN 65 106 772 696. This article contains general advice which does not consider your particular circumstances. You should seek advice from HLB Mann Judd Wealth Management (NSW) who can consider if the strategies and products are right for you.