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10. Transition to Retirement Pension Age 55 to 60

A transition to retirement pension strategy also known as a “TRAP” involves starting a transition to retirement pension after age 55 but before age 60, living on the pension income and then arranging for all or part of your salary income or other practice income to be paid to the SMSF as deductible contributions.

The transition to retirement rules are, in summary, designed to allow/encourage people to continue to work after age 55 on a reduced and reducing basis, and still produce and not draw government benefits in the meanwhile, rather than being forced to retire at age 55. The idea is if you promise to not take a lump sum until a condition of release has been reached (eg you stop work permanently or you reach age 65) you can access part of your super after age 55 without stopping work.

TRAPs combine with salary sacrifice to create a simple tax planning strategy that may be useful for doctors between the ages of 55 and 60. The idea is simple: the doctor starts a pension, which means all investment earnings in the SMSF become tax free, and the pension income is taxed concessionally in the doctor’s hands. The doctor then arranges for all or part of his or her other practice income to be paid to the fund as deductible contributions, taxed at just 15%. If the doctor is not married, these contributions are capped at $500,000. But if the doctor is married, these contributions effectively become $100,000 (or $75,000 if the doctor’s spouse is under age 50).

In summary, the doctor lives on the concessionally taxed pension income, and possibly other investment income, investment reserves or even borrowings, while practice income is in effect taxed at no more than 15%, ie in the form of contributions in the hands of the fund.

Cost benefit analysis

Where the doctor is under age 60 a cost benefit analysis is needed before the strategy is implemented. The cost of starting the TRAP, and the tax cost on receiving the (albeit concessionally) taxed pension income, needs to be compared to the tax savings generated the tax exemption on the fund’s investment earnings. In summary, the lower the doctor’s tax profile, and the larger the expected income tax liability in the fund (including unrealized CGT liabilities) the more likely it is that a TRAP should start after age 55 but before age 60.

What happens at age 60?

At age 60 there is no downside at all to starting a TRAP, since the doctor’s pension income will be completely tax free in the doctor’s hands.

All doctors with superannuation benefits should be pensioners by age 60. There are no exceptions: its simple mathematics and you cannot lose

ATO view of this strategy

The ATO accepted this arrangement as effective when it released a media statement on 17th November 2005 as follows:

Guidance on transition to retirement pensions: Media Release Nat – 2005/66

The Tax Office today clarified how transition to retirement pensions will be treated

The general anti-avoidance provisions will not apply where taxpayers are simply commencing a transition to retirement pension, and making salary sacrifice contributions to superannuation.

Some strategies have encouraged people to draw down on their supern by accessing a transition to retirement pension while salary sacrificing back into their retirement savings. Under these arrangements the pension provides an additional source of income, while salary sacrifice tops up the taxpayer’s retirement savings.

Tax Commissioner Michael Carmody said “there has been some media interest recently in the promotion of this strategy. Arrangements entered into in a straight -forward way are consistent with the operation of the law, and we do not see grounds for applying anti-avoidance rules.

“For example, an eligible person may take out a pension under the transition to retirement rules. At the same time, that person may engage in an effective salary sacrifice arrangement and contribute to a complying superannuation fund for their own benefit.

“We would only be concerned where accessing the pension or undertaking the salary sacrifice may be artificial or contrived.”

Individual taxpayers can seek further clarification about the consequences of their particular arrangements. This can be done by requesting a private ATO.

The transition to retirement measure was introduced to allow eligible Australians to access their superannuation through an income stream without having to retire permanently from the workforce.

17 November 2005