To understand whether a transition to retirement pension is worthwhile, you first need to understand the transition to retirement tax. The taxation of transition to retirement income streams is the same for everyone in application, but the actual tax payable can be different.
The calculation of tax on transition to retirement pensions may seem complex; but once you understand how it works, it’s all quite simple. Let me show you how.
Transition to Retirement Tax
There are two types of taxes you need to be aware of with transition to retirement pensions: (i) investment earnings tax and (ii) pension payments tax.
(i) Transition to Retirement Tax on Earnings
When you start a transition to retirement pension, your pension balance is invested in some way or another. Your balance may be invested in managed funds (which includes Industry Fund investment options), shares, term deposits, bank accounts, or even direct property (if you have a SMSF).
All of these investments produce investment returns in the form of income (interest, distributions, dividends, rents, etc.) and/or capital growth (increase in value).
The tax rate on investment earnings within a transition to retirement account is 15%. This is the tax rate applied to all income generated from investments within your account.
Additionally, all realised capital gains are taxed at 15% in super in the year the investment is sold. However, if the investment sold was owned for longer than 12-months, a 1/3rd capital gains tax discount is applied to the realised gain. This means only the remaining 2/3rds of the capital gain is taxable. For simplicity, you can assume that this results in an effective 10% tax rate on realised capital gains for investments that were owned for longer than 12-months.
When Is Transition to Retirement Earnings Tax Payable?
If you hold your TTR pension account with an Industry Super Fund, all tax on investment earnings are calculated and paid behind-the-scenes, because these funds run pooled investment strategies. When a unit price for an investment option is declared by the investment manager, this price is after taxes have already been taken into account. Therefore, you will not see earnings taxes being deducted from your balance. It doesn’t mean you don’t pay the tax, it just means you don’t see it.
If you hold your TTR pension through a retail superannuation fund, you should see investment earnings tax and CGT being deducted from the main cash account within your TTR pension. The tax is calculated and payable when the super fund completes the annual tax return. This is automatically paid for you by the trustee of your super fund.
If you have a self managed superannuation fund (SMSF), the investment earnings tax and CGT is payable once the SMSF completes its tax return. The tax is then usually paid from the SMSFs main bank account, arranged by the administrator/accountant of the SMSF.
(ii) Transition to Retirement Tax on Pension Payments
The tax on transition to retirement income streams depends on two factors: your age and the tax components that make up your balance.
Let’s begin with age.
If you are aged 60 or over, all TTR pension payments are received by you tax free, regardless of the tax components.
If you are under age 60, the pension payments are assessed based on the tax components that make up your balance.
Your TTR pension balance will consist of taxable components, tax-free components, or a combination of both. Once you start a TTR pension, the proportions of each component that make up your balance will remain the same for the life of the pension. For example, if you start a TTR pension with $400,000, consisting of $50,000 tax-free components and $350,000 taxable components, then your TTR pension will always be 12.50% tax-free and 87.50% taxable, because all investment earnings are allocated proportionately to each component and all pension payments are withdrawn proportionately from each component.
While under age 60, the tax free portion of a pension payment will be received completely tax free. The taxable portion will be included as taxable income, together with any other taxable income you may have (e.g. wage) and taxed at your marginal tax rate. However, a transition to retirement tax offset equal to 15% of the taxable component is received, which reduces the tax payable.
Watch this TTR Pension video to understand the TTR Pension rules:
Transition to Retirement Tax Example
This example shows how TTR pension payments are taxed and how TTR pension earnings are taxed.
TTR Pension Payments Tax
Let’s say you are 59 years of age and started a TTR pension on 1 July with $400,000, consisting of $50,000 taxable components and $350,000 tax free components. Based on this, the transition to retirement minimum and maximum income withdrawal thresholds would be $16,000 and $40,000. That is, you must draw an income from the TTR pension between these amounts, inclusive. Let’s say you decided to receive $24,000 in pension payments throughout the course of the year.
Of this $24,000, $3,000 (12.5%) would be received completely tax free. The remaining $21,000 would be counted as taxable income. We will also assume that you had work-related income of $50,000 throughout the year. Therefore, the $21,000 of taxable TTR pension income would be added to your $50,000 work-related income and the combined $71,000 would be taxed at your marginal tax rate. This would result in tax of $14,962. However, you would receive a transition to retirement tax offset of $3,150 (15% x $21,000), which would reduce this tax payable to $11,812.
TTR Pension Earnings Tax
If throughout that same year, your $400,000 TTR pension balance generated investment income of $12,000, the TTR earnings tax rate of 15% would be applied and $1,800 in earnings tax would be payable. This would be paid from your super balance, not by you personally.
If any investments within the TTR pension account were sold throughout the year, 15% CGT would be payable on any profit (reduced to 10% if the investment sold was owned for longer than 12-months)
While TTR pension income is received tax free if you are aged 60 or above, TTR pension earnings tax applies to you in all cases, regardless of your age.
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Frequently Asked Questions
Here are some frequently asked questions about Transition to Retirement Tax.
Is Transition to Retirement Income Taxable?
Transition to retirement income is taxable if you are under the age of 60. Specifically, the taxable component portion of the transition to retirement income is taxable and the tax-free component portion is not taxable. Once you attain age 60, all transition to retirement income is tax-free.
What is the Transition to Retirement Income Tax Offset?
The transition to retirement tax offset is calculated as 15% of the taxable component portion of the pension payments received. This tax offset reduces your personal tax payable and is designed to be a refund of contributions tax that was initially paid on deductible (concessional) contributions. Importantly, it is a tax offset and not a tax rebate. Once you attain age 60, there is not a transition to retirement tax offset, because all TTR pension payments are received tax free.
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