How to know if transitioning to retirement is right for you

Your retirement is almost certainly going to stretch out longer than that of your parents, and that’s both a good thing and one that creates potential issues previous generations haven’t had to tackle.

For several decades leading up to the 1970s, life expectancy for the average 65-year-old was fairly static at about 12 years for men and 15 for women, but since the ‘70s it has slowly crept up to 19 years and 22 years respectively.

Longer lives generally mean a longer period in retirement. A Treasury report from 2010 shows that until the 1970s, the amount of time a person aged 65 could expect to draw the Age Pension was about 12 years. More recently, though, 18 years on the pension is closer to the norm.

As a result, the government said in the Budget 2018-19 that it expected spending on the pension to grow from about $45 billion currently to almost $54 billion in 2021-22, an increased cost to the taxpayer in real terms of almost 7 percent, which the government put down to “demographic factors” i.e. an ageing population.

That’s in part why Australians are increasingly expected to supplement or replace the pension with a retirement income from superannuation savings, whilst at the same time,  the government increases the pension eligibility age. The trouble is that often the average worker in their early 60s doesn’t have enough savings in super to support them through what’s going to be the longest retirement period the country’s ever known.

The Association of Superannuation Funds of Australia (ASFA) says in an October 2017 report that as of 2015-16, the average super balance at retirement (put at between the ages of 60-64) was $270,710 for men and $157,050 for women – some way from the $500,000-plus balance the average couple would need, according to ASFA, on top of the Age Pension to live comfortably in retirement.

In a double-whammy, health expectancy – the number of years a person can expect to stay in good health, without disease or injury – hasn’t increased as fast as life expectancy, so although it may be ideal from a financial standpoint to continue working past the traditional retirement age of 65, some workers may be unable to.

To help bridge the gap between the length of time modern 60-pluses are expected to spend in retirement, the amount of super they’ve saved and their ability to continue in the workforce, the government introduced a new strategy, in 2005 bringing in an option allowing people to ‘transition to retirement’ so they could continue to add to their superannuation savings while easing out of the workforce before the age of 65.

Bryan Ashenden, the head of financial literacy and advocacy at BT Financial Group (BTFG), advises, though, that a TTR, as transition-to-retirement products are commonly known, shouldn’t be entered in to without plenty of thought.

“You need to be aware that there are some quite restrictive rules about how you run a transitional retirement income stream” he says. “You should go into it fully aware.”

This is particularly the case because as of July 1, 2017, the government removed some of the tax benefits associated with TTRs, making them a less tax effective and potentially a less attractive option for most people.

So, what are TTRs and how could they work for you? These points will help explain, although for an in-depth answer, it’s important to seek professional financial advice that’s specific to your circumstance.

Understanding the basics

A TTR pension or TTR income stream involves transferring some of your super balance from your ‘accumulation’ account – where it sits while you’re working and making contributions – to a ‘drawdown’ income stream account.

The remainder of your balance remains in your accumulation account so it can continue to earn potential investment returns and accept contributions from you and/or your employer.

You then draw an income stream (also known as an allocated pension or an account-based pension), while reducing your working hours.

The upsides of a TTR

• If you’re winding down your work hours and aim to start a new business venture in retirement or simply wish to retire early, a TTR allows you to reduce your working hours without a sudden drop in income, because the income drawn from your account-based pension offsets the reduced income from your employer.

Ashenden says the ability to transition to retirement can also be helpful for a couple with a reasonably sizeable time period between their respective retirement dates to smooth the income disparity they may encounter. “One person may want to maintain their working lifestyle, while the other person is going to have a reduced income because they’ve retired, and a TTR could help smooth that difference,” he notes.

• Your employer must continue to make the mandated super contributions to your accumulation account if you continue meeting the minimum work test, regardless of your age. These contributions can potentially offset some of the income you’re drawing down. There’s also the potential for you to make concessional contributions if your budget allows, up to a cap of $25,000 (although this is reduced by mandated employer contributions).
• You may pay less income tax overall, because the income drawn from your super is tax-free once you’re aged 60 or older. If you’re aged 55-59 your super pension payments could have both tax-free and taxable components specific to your financial circumstances, with the taxable portion taxed at your marginal tax rate minus a 15 per cent tax offset.

BTFG’s Ashenden explains that it is possible for some workers to increase their own contributions to super by using the tax-free portion of their TTR income to replace an employment income that would’ve been more heavily taxed, thus freeing up some money to put into their accumulation account. But this is a complex financial strategy that shouldn’t be undertaken without professional financial advice.

The downsides of a TTR

• You’re not permitted to open a TTR until you reach your preservation age, which differs depending on the year you were born. The minimum preservation age is currently 57 and gradually will rise to 60.
• There are limits to how much and how little income you can draw down each year from super under a TTR arrangement; from between 4 and 10 per cent of your total super balance.

BTFG’s Ashenden says that complying with the limits is particularly important. “There can be serious consequences if your drawdown isn’t in accordance with the law, in that the tax office could impose a penalty on you,” he warns.

• You can’t take the income you’ve drawn down as a lump sum, which means this retirement strategy may not be suitable for people who wish to pay off a large debt or spend a significant amount at the start of their retirement.
• Until July 1, 2017, the returns on a TTR pension-holder’s accumulation account were tax-free, but they’re now subject to a tax rate of 15 per cent.
• Likewise, until that date, people aged 49 and above could contribute up to $30,000 to their super balance at a concessional tax rate, but that cap was changed to $25,000 for everyone. (These rules will ease somewhat from 2019-20 for workers with a super balance of less than $500,000, as they’ll be permitted to carry forward the unused portion of their concessional cap into subsequent years, within strict limits.)
• By drawing down an income from your super, you’re reducing the amount of money you have to sustain you over your retirement. This is possibly the most important consideration when it comes to TTRs – any additional contributions you make to super while transitioning to retirement may not be sufficient to cover that drawdown, leaving you with a lower super balance at retirement.

“You need to be conscious that you’re pulling money out of the tax-effective environment and be sure you’re taking it out for the right purposes,” Ashenden advises. “There are some very justifiable reasons someone might use a transition-to-retirement income stream, but just because you can do it doesn’t mean you should – it needs to be right for your circumstances.”

Do you worry about how you’ll continue to work until your Age Pension eligibility age? Have you considered transitioning to retirement with part-time work?

Things to know: The information in this publication is general information and factual only. It does not constitute any recommendation or financial product advice. It is an overview only and it should not be considered a comprehensive statement on any matter or relied upon as such. You may wish to consider getting your own independent professional financial and taxation advice or visit the ATO website for further information. BT Financial Group (BTFG) is a division of Westpac. © Westpac Banking Corporation ABN 33 007 457 141 AFSL and Australian credit licence 233714

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.