Transition to retirement

Transition rules provide great choices, even if you’re not ready to retire just yet

Australia has one of the most progressive retirement savings systems in the world. In 2007 the system took another major step forward with the launch of transition to retirement rules.

Steve Davis, General Manager, Personal Financial Services with Australian Unity says the transition to retirement rules brought the system up to date with the contemporary needs of baby boomers.

“Super came into being in the days when you were expected to work until you reached age 60 or 65, then suddenly quit and live out a relatively short retirement.

“That’s changed dramatically. We’re living much longer and healthier lives, so a complete exit from working life when you still have 20 or more good years ahead of you no longer appeals to many people.

“Stepping back gradually from full-time work is one way to achieve a better balance. It also helps to have a transition to retirement strategy if you need to keep working to boost your savings. Working fewer hours per week over a longer period is much easier to manage.”

The transition to retirement rules give Australians approaching retirement choices that could improve their lifestyle and their finances. There are two main ways to take advantage of the transition rules: work fewer hours after age 55 without suffering a drop in income, or keep working full-time and build your super savings even more quickly.

“Both approaches take advantage of the tax advantages inherent in super to improve your position,” says Steve. “They are smart strategies that the government encourages because it ultimately means you are better placed to fund your own retirement, rather than rely purely on the Age Pension.”

Work fewer hours

If you want to wind down your career by working part-time, the transition rule can enable you to top up your income using your super. As long as you are over 55 you can start an account based pension with all or part of the savings in your super fund.

An account based pension (ABP) is an investment that pays you a regular and tax effective income in retirement or in the transition phase. You invest money from a super fund into the ABP. The ABP then pays you a regular income comprised of interest and capital until your account runs out.

You can use the ABP income to replace your forgone salary so your net income remains the same, even though you are working less. And, importantly, because you are still earning income, you don’t need to draw down as much of your super as if you were fully retired.

Boost your super savings

If you want to stay working full-time, but need to build up your super, you can use the new rule to help you.

You start by increasing the amount of salary paid directly into your super fund by salary sacrificing. Then start an account based pension using some or all of the money in your super fund to make up part or all of the income you sacrificed. You can do this even though you are still working full time (as long as you are aged 55 or over).

With this arrangement you will be in a much better position because you are effectively paying less tax to receive the same amount of cash in your pocket every week.

Advice will minimise risks

While the additional flexibility and choices that the transition rule brings are a wonderful thing, Steve says there are risks of making a mistake.

“Taking money out of super to start an account based pension should only be done with advice from someone who understands all the tax, retirement income and Centrelink consequences. Your super fund is your only chance for a comfortable retirement. We urge people not to do anything without professional advice.”

Case study: Combining the transition to retirement rule with a salary sacrifice strategy to build super savings*

Mary is 55 and earns $90,000 a year, which gives her $67,300 after tax. From this Mary invests $19,300 into super, leaving her $48,000 to live on.

Mary currently has $220,000 in her super fund. She enjoys her job and plans to keep working for another five years, but realises she needs to increase her super at a faster rate.

One solution could be as follows:

• Transfer her super to an account based pension,
• Draw income of $9,843 p.a. from the account based pension, and
• Salary sacrifice $41,900 p.a. to super.

This should result in Mary having the same income ($48,000) to live on each year, made up of:

Mary will accumulate $59,774 more in super savings over the next five years than if she had not adopted this strategy. This improvement arises because of the additional contributions Mary makes to super as well as the tax efficiencies created by this strategy – and it has been done with no loss of net income.

Once Mary has reached age 60, her income from the ABP is completely tax-free. She does not even have to include it in her tax return.

*Assumptions: 2010/11 tax rates used. Assumes $50,000 p.a. maximum deductible contribution rule is retained for people 50+. ABP earns 8% pa, and super earns 6.8% pa. Both cases include Mary’s employer’s super guarantee contributions.

Get the right advice

This information is intended as general information only. It does not take into account your objectives, financial situation or needs. For this reason, before making any major financial decision, it is important to seek professional financial advice. See your financial adviser.