The new super landscape - be retirement-savvy
By Graeme Colley
1 July 2017 marks the start date for a raft of super reforms first announced in the 2016 Federal Budget.
Key amongst these is the introduction of a $1.6m pension balance cap. And with the clock ticking, it is important to understand the ramifications of this change and how best to navigate it.
But first, let's look at what the relevant law says about retirement.
By the book: defining retirement
In superannuation, the notion of retirement is all important. Simply speaking, it is the milestone, the life event, that permits savings to be accessed. But what is the legal definition of retirement? This resides in the Superannuation Industry (Supervision) Act 1993 (SIS Act).
Under age 60
If a person has reached preservation age (as determined by their birth date) but is under 60, retirement occurs when they cease gainful employment.
The cessation of employment must be ‘full and effective’ – in other words it must be bone fide and there must be no intention to resume work, on either a full or part time basis. However, in practical terms an individual can resume working up to ten hours per week – a level which is not considered to be ‘employment’ for superannuation purposes.
Age 60 and over
For those aged 60 to 64, retirement occurs where at least one gainful employment arrangement has ceased. There is no requirement for all gainful employment to cease.
Let’s consider the example of Fred, aged 62, who currently has two part-time jobs: at an accountant’s office from Monday to Wednesday, and a hardware store on a Thursday and Friday. The store offers to extend Fred’s work to a Saturday, this being their busiest day. Not wanting to work six days a week, Fred ceases his job with the accounting firm in favour of the hardware store.
Whilst in his mind Fred hasn’t retired, he has actually satisfied the SIS Act’s retirement definition, enabling him full access to his super, either as a lump sum, pension or combination of both. Whilst he may not immediately intend to tap his super, it would be worthwhile recording the change in circumstances with his fund. This will re-classify his benefit as ‘unrestricted non-preserved’ making it available to him when required.
The SIS regulations define ‘gainfully employed’ to mean “employed or self-employed for gain or reward in any business, trade, profession, vocation, calling, occupation or employment.” This definition is broad enough to cover any activities undertaken by someone for which a payment is received. It includes anyone engaged as an employee, a contractor, a professional, those engaged in religious callings and so on. The amount of the payment, the level of effort involved and whether it results in a profit or loss is immaterial.
An activity is not considered gainful employment where the only form of payment is an allowance or re-imbursement for incidental expenses. This would occur in the case of voluntary work where a person may be reimbursed, in part or in full, for the cost of meals, travel and other incidental items. It would also not include a person receiving a government allowance for looking after a disabled relative, or a relative who undertakes child minding on an ad hoc basis. As an aside, prisoners who receive an allowance for making goods when serving their time are also not gainfully employed for purposes of the definition.
Impact of super reform
Now let’s look at the interplay of the SIS Act’s retirement definition and the proposed superannuation reforms.
Effective 30 June 2017, a $1.6m balance cap is intended to be imposed on pension income streams – both new and existing. Provided the total balance(s) of the relevant pension(s) does not exceed the cap, investments earnings will be tax free.
Where the $1.6 million cap is exceeded a penalty tax applies to any excess. Anyone with more than $1.6 million in super should keep a careful watch over amounts that are used to commence income streams, to ensure the pension balance cap is not exceeded.
Transition to retirement incomes streams
Amounts used to commence a transition to retirement income stream (TRIS) are not subject to the cap, as investment earnings within a TRIS will be taxed in the fund at the 15% tax rate from 1 July 2017.
Even though a TRIS is excluded from the cap, once an individual has ‘retired’ or met any other condition of release free of a cashing restriction – such as reaching age 65 – the TRIS will auto-convert to an account based pension and consequently be subject to the $1.6m balance cap. A trap may exist if the auto-conversion results in the $1.6m cap being exceeded.
Case study – the TRIS trap
Let’s consider Frank who is 61, has a TRIS worth $1.7 million and a full time job as a sales manager.
In the run up to a federal election, he takes leave from his full time job to work for the Electoral Commission on a casual basis. The casual work lasts for a few weeks and ends once all the votes have been counted. As Frank is at least 60 years old when he ceases his Electoral Commission job, he is considered to have retired for superannuation purposes (similar to the previous example of Fred).
In this situation, with Frank having met the legal definition of retirement, his TRIS will auto-convert to an account based income stream. The value of the account based income stream will be counted against the $1.6 million transfer balance cap. As Frank has exceeded his transfer balance cap by $100,000, it will be subject to an interest penalty and he will be required to transfer at least $100,000 to an accumulation fund.
Retiring under age 60
If Frank was between his preservation age and 60, the same situation would occur if he was in receipt of a TRIS, ceased employment permanently and did not intend to return to work.
Reaching age 65
Similarly, if Frank did not cease any employment arrangements between age 60 and 64 and reached age 65, all of his superannuation benefits would automatically become ‘unrestricted non-preserved’, regardless of his work status. His TRIS would auto-convert to an account based income stream and in doing so he’d face the same potential trap.
Those who hold or are contemplating a TRIS and are around the age of 60 should understand the ramifications of being legally deemed as ‘retired’. It is worthwhile having the situation reviewed to avoid unintended consequences. Namely: the auto-conversion of a TRIS to a regular account based pension and resulting tax implications.
Once the TRIS has commenced, an alternative for anyone approaching retirement could be to fully or partially commute it to a lump sum, then return it to an accumulation fund to help avoid the possibility of penalty tax.
With a new super landscape rolling into view, now more than ever it pays to be retirement-savvy.