SELF-MANAGED SUPER FUND GUIDE 2017
Income streams or pensions
Transition to retirement income streams
SMSFs and withdrawing money
Chapter 7 - Getting money out of super
There are two main ways in which a person can withdraw money from superannuation. The first is as a lump sum and the second is in the form of an income stream (typically known as a pension). We introduced each of these forms in our previous e-book. These introductions are reproduced below.
When deciding how best to withdraw money, you need to consider how you will use the withdrawn money. If the money is going to be saved outside of superannuation, with smaller amounts used to finance lifestyle on a month by month basis, then it generally makes sense to leave the bulk of the money within superannuation and to withdraw what is needed as a pension over time.
Conversely, if the money is going to be immediately spent, then a lump sum a make more sense.
Income streams or pensions
When using an income stream, you keep the majority of your benefits within superannuation and withdraw a relatively small amount each year. The yearly withdrawal can happen all at once, or in smaller amounts during the year (for example, monthly).
The government encourages people to use this method as this method preserves more superannuation benefits for future use, which reduces reliance on social security payments later in life. The main encouragement for people using an income stream is that no tax is paid on investment returns for assets being used to finance a pension. This includes both income returns (such as interest or dividends) and capital gains.
This means that the superannuation fund becomes a tax-free investment vehicle once an income stream has been commenced. Zero tax is hard to beat!
From 1 July 2017, there are a couple of significant modifications to the income stream arrangements. The first is to restrict the zero tax arrangement to income streams paid after a full retirement or after the member turns 60. Prior to 1 July 2017, assets used to finance what is known as a ‘transition to retirement’ income stream (see below) also enjoyed tax-free status on their earnings and capital gains.
Secondly, the tax-free treatment for earnings generated on assets used to finance an income stream is now limited to an amount of assets worth no more than $1.6 million. For the vast majority of people, this upper limit is well in advance of their total superannuation, and so the limit does not really have an impact. For those people fortunate enough to have more than $1.6 million in superannuation benefits, earnings on assets in advance of $1.6 million remain taxable at the standard superannuation tax rates of 15% for income and 10% for capital gains on assets held for more than 12 months.
The tax-free status for superannuation funds that are paying an income stream generally means that anybody who has retired and has met a condition of release should commence payment of a pension. Under the rules of a pension, the money actually has to be withdrawn from superannuation, but in many cases it is possible for a member to re-contribute excess money back into their superannuation fund in the form of a non-concessional contribution. People can make use of such a ‘re-contribution strategy’ up to and including the age of 74.
TRANSITION TO RETIREMENT INCOME STREAMS
A transition to retirement income stream allows a person aged 55 or over to start drawing income from their superannuation benefits while still working. The idea behind this type of pension is to discourage people from leaving the workforce altogether. As an incentive to stay in work, when transition to retirement pensions were first introduced, it was decided that earnings on assets used to finance the pension would not be taxed. This included capital gains, such that superannuation fund for people using a transition to retirement pension basically became a tax-free enterprise.
This was a generous incentive and in the 2016 budget, it was decided that this was too generous an incentive! As of 1 July 2017, earnings and capital gains on assets used to finance a transition to retirement pension are no longer tax-free. This will reduce the benefit of such a pension for a lot of people. Basically, anyone who does not need the pension to finance their daily lifestyle probably does not need to bother commencing a transition to retirement income stream. However, for people who are working but really do need to access their superannuation to finance their lifestyle (for example, people working on a very part-time basis) a transition to retirement pension may still make sense.
Lump-sum withdrawals from superannuation are often used to finance some form of one-off payment. This can include things like paying out home loans, purchasing a new home, paying for holidays, buying a new car, helping adult children out financially, et cetera.
If a person elects to withdraw a lump sum from their superannuation fund, they do not have to withdraw their entire balance. Whether a person should withdraw more than they need to finance a particular purchase will depend on how they will invest or otherwise use that money in excess of their needs.
Generally, it makes sense to leave as much wealth within low taxed environment of superannuation. However, individual tax circumstances can vary, and so it is always worth taking advice when considering how to treat money held within superannuation for which there is no immediate need.
Self managed superannuation funds and withdrawing money
As outlined above, once a member commences a pension from their superannuation fund, assets used to finance that pension are no longer taxed. This includes capital gains, even if the asset was purchased prior to the commencement of the pension. This can create a powerful investment strategy for self-managed superannuation funds.
Put simply, an SMSF can invest in growth assets that predominantly target capital gains, with a view to holding that asset until after all members of the fund commenced pensions. In so doing, the fund negates any capital gains tax being paid on that asset.
Consider the example of a husband and wife who are running a business together. They establish a self-managed superannuation fund and the fund borrows money the purchase their business premises. The business then leases those premises from the fund, paying a market rent to do so.
At the age of 55, the couple decide to sell the business. However, they do not sell the business premises, instead entering into a new 10 year lease with the new owners of the business. At the age of 65, both members of the couple have established a pension and at this point they sell the business premises for a substantial capital gain, on which they do not need to pay tax.
This is an example of how the investment strategy of a self-managed superannuation fund was both consistent with, but also diversified from, the investment strategy of the members in their own right.