Transition to retirement strategies can help clients achieve their financial and lifestyle objectives in retirement.
Over the coming years, 5.5 million people born between 1946 and 1964 will retire, increasing the demand for retirement advice. This article, sponsored by Russell Investments, discusses the importance of pre-retirement planning and the benefits of a smooth transition to retirement.
As individuals approach retirement age, it is essential to plan for a smooth transition into this new phase of life. While retirement is a significant milestone that usually marks the end of a long and fruitful career, it can also be a source of stress and uncertainty. Pre-retirement planning is critical to ensure that your clients can enjoy a comfortable and financially secure retirement. Detailed pre-retirement financial planning can help them prepare not just financially, but mentally and emotionally for the changes that come with retirement.
The ageing cohort of Australia’s baby boomers represents a significant challenge and opportunity for financial advisers. As wave after wave of this demographic reach retirement age, they will have unique financial needs and considerations that will require specialised guidance and planning.
For financial advisers, this means that they will need to cater to the specific needs of baby boomers; help them to navigate the complexities of superannuation, create appropriate retirement income streams, and estate planning. This may involve developing new strategies and investigating investment products tailored to the changing needs of this demographic, as well as offering personalised advice and support.
Increased longevity means that retirees today can expect to live for 25 plus years and an important element underpins their ability to achieve this – a sound financial plan, one which needs to commence before they hit retirement. By doing so, financial advisers can help their clients to navigate the complexities of retirement planning and ensure that they are able to enjoy a secure and comfortable retirement.
Pre-retirement planning
In 2020, 65 percent of Australians had balances below $250,000 at retirement; while this proportion is expected to decrease to 30 per cent by 2060[1], it’s little solace for clients retiring in the coming years. Even when considered in conjunction with the Age Pension, a superannuation balance of this quantum is unlikely to provide the retirement lifestyle many baby boomers expect. This reinforces the need for pre-retirement planning.
The Investment Trends 2022 Retirement Income Report is an in-depth study of Australians’ attitudes towards retirement and post-retirement issues. The report highlights that confidence levels have plummeted to a ten year low among pre-retirees when it comes to their feelings of preparedness for the next stage of their life. Year on year there was a significant decrease, with confidence levels dropping a whopping 25 percent between 2021 and 2022.
This lack of confidence is driven by a number of factors cited in the report: inflation and the spiralling cost of living, increases in cost of medical services, fear of outliving retirement savings, and income expectations not being met. According to Investment Trends, non-retirees expect their retirement income to be around $3,200 per month but perceive $4,300 per month as the desired level, roughly on par with ASFA’s[2] budget for a comfortable lifestyle for a single person ($49,462), but below that required for a couple ($69,691).
Interestingly, Investment Trends’ study found that the fear of not having enough money in retirement is driving non-retirees to seek retirement related information and wanting to be better prepared. This presents advisers with an opportunity to educate and prepare clients for retirement, to explain the retirement income products available and prepare a retirement strategy appropriate for each client.
The transition to retirement
When working with pre-retirement clients, a Transition to Retirement (TTR) strategy can be useful for those clients aged 58 plus, who have reached their preservation age (figure one) and are still working.
A TTR strategy generally involves restructuring the way your client receives income by enabling them to top up the income received from their employment with a regular income stream from their super through a transition to retirement pension. This means your client receives income from two sources: their employer and their super fund. You can also take advantage of certain tax rules to boost your clients’ retirement income.
It’s important to note that there’s a minimum and maximum amount clients may withdraw from a transition to retirement pension each year; until retirement or age 65, the maximum income your client may draw in any year is 10 percent of the account balance.
This approach is flexible. If a client starts a transition to retirement pension but no longer needs the income, the pension can be stopped at any time and the client can return their focus to accumulating super.
TTR strategies
1. Lifestyle booster: subsidise a move into part-time work
Clients approaching retirement may want to reduce their working hours, but not their income. They may still have debts to service, renovations scheduled or travel plans. Clients can ease into retirement and boost their lifestyle by working fewer hours and supplementing the reduced income with a regular income from their super fund, via a transition to retirement pension.
Case study one: Stepping into retirement
Mark was born on 27 March 1961 and decided to move from full time to part time employment. He wants to not only ease his way into retirement, but to take advantage of his good health to do as much travelling as possible.
Following advice from his financial planner, Mark and his employer agree to reduce his employment to part time; however instead of working fewer days per week, Mark continues a five day week but is able to take additional annual leave each year to fulfil his travel plans.
As Mark has reached preservation age, his adviser facilitates the transfer of a portion of his super savings into a TTR pension account that his superannuation fund has established for him. Each month, a regular sum is transferred from the TTR account to his savings account.
Mark receives his regular salary from his employer, but it’s lowered in line with his reduced hours. The extra income from the transition to retirement pension tops up his overall income. The combined income means that Mark can continue to maintain his lifestyle while ticking off some bucket list items as he makes the transition to retirement.
2. Income booster: provide an increased level of income
Some clients might wish to increase their income in their pre-retirement years. This might be to pay down debt before retirement or to meet other financial or lifestyle objectives. This can be achieved by your client maintaining their existing work arrangements and drawing from a transition to retirement pension.
At the same time, the client can take advantage of paying a reduced level of income tax by electing to salary sacrifice into their super fund, which can then be drawn as a transition to retirement pension. For those clients aged 60 or over, pension income is tax free. For those under 60 (but have met their preservation age), pension income is taxed at their marginal tax rate, however a 15% tax offset is received.
Case study: Discharging debt before retirement
Paul was born on the 22 May 1960. He and his wife Julie, born later in 1960, have a lot of plans for retirement – first and foremost, a year or two as ‘grey nomads’ taking to the open roads in their caravan. However, projections show they will take an outstanding mortgage of around $150,000 into retirement. The impact of this on their retirement income is of particular concern, particularly given recent rate rises and increasing repayments.
In consultation with their financial adviser, they decided that rather drawing a lump sum from the super fund upon retirement, they would use a transition to retirement pension to increase their pre-retirement income and focus on paying the mortgage as quickly as possible. While they may need to use a small amount of capital to pay it out when they do retire, this strategy should meaningfully reduce it. This strategy enables the couple to retain as much capital as possible in their super fund to generate income to support their eventual retirement.
3. Super booster: increase a super balance
It’s no surprise that a significant proportion of people retiring today may not have a sufficient level of retirement savings to get them through 25 plus years of retirement. For many, compulsory super only came in toward the end of their working lives, too late for many to amass a significant nestegg. Women, who are more likely to have held part time roles and taken career breaks, are typically worse off.
A commonly used TTR strategy is for clients to contribute a greater portion of their earned income into super via a salary sacrifice arrangement. At the same time, the client draws a transition to retirement pension from their super fund, to maintain their level of income.
As the client continues to work, they continue receiving super guarantee contributions from their employer. They can also make salary sacrifice contributions and rollover balances from other super accounts they hold to boost their primary super account. This is an effective way to grow a superannuation balance.
As described earlier, clients who choose to salary sacrifice into super could pay less income tax. Using this strategy to top up super rather than other investments is also tax effective; investment earnings on the investments that fund the pension are taxed at the concessional rate of up to 15%, whereas tax on any investment earnings outside super is generally higher.
Case study: Adding to super savings
Michael, 60, is still working full time, earning $70,000 plus his super guarantee contribution. He plans to retire when he is 65. With five years to go, he wants to bolster his retirement savings. While he will be limited by his concessional contributions cap of $27,500 a year, his adviser looks into taking out a transition to retirement pension so he can commence a TTR strategy and salary sacrifice more into his super.
Michael salary sacrifices as much of his salary as possible into his existing super account, and draws down an amount from his pension account, so that he still has the same amount of money on which to live. The maximum he may draw down is 10% of his pension account.
In one year, Michael can save over $4,000 in tax and contribute this to his super by putting it straight into his existing super fund. Over the five years between age 60 and 65, Michael can boost his super by over $20,000 while maintaining the same take home pay. This strategy is tax effective, because income payments from a pension account are tax free for people aged 60 and over.
Things to consider with a TTR
There are a number of issues to consider when discussing a TTR with your clients.
Contribution limits
The government imposes limits as to how much an individual can contribute to super each year. For the 2022/23 and 2023/2024 financial years, an individual can make concessional (or before-tax) contributions to super of up to $27,500.
Concessional contributions include superannuation guarantee contributions made by employers, personal contributions (for which the client has claimed a tax deduction), and any voluntary salary sacrifice contributions made. Contributions above the limit will be taxed at the client’s individual marginal tax rate plus an Excess Concessional Contributions charge.
Some strategies can reduce a client’s overall super balance
Removing money from an accumulation superannuation account could impact its potential earnings over time, which in turn can reduce the account’s balance at retirement and its ability to generate an income stream in the future.
Drawing down an income
How much income your client draws down will depend on how much they need and the other sources of income they may have. As clients get closer to retirement, their income needs tend to reduce, and they can afford to salary sacrifice into super without having to replace the lost income. The maximum income they may draw down in any year is 10% of the account balance until they reach the age of 65.
Defined benefit members
If your client is in a defined benefit scheme, the amount they can transfer from their existing account into a pension may be limited to the accumulation portion of their benefit. However, there may be the option to transfer out of the defined benefit plan and commence a pension with the whole balance. This will vary between defined benefit schemes.
Centrelink benefits
The income received from a transition to retirement pension may impact the client’s taxation status and eligibility for Centrelink benefits. Income from financial assets such as superannuation form part of Centrelink’s income test for pension eligibility.
SMSFs
As long as the SMSF member meets the TTR preservation age requirements and has a nil cashing restriction, they can generally access their superannuation benefits in other ways and don’t need a transition to retirement pension. In these circumstances, the trustees can start paying the member a normal account-based pension, or the member’s benefits can be paid as a lump sum without having to go through the process and cost of setting up a pension.
Income stream
Clients can only access their super benefits as a ‘non-commutable’ income stream, one that cannot be converted into a lump sum. This generally means clients are not able to take super benefits as a lump sum payment while they are still working.
Transitioning from a working life to retirement can be challenging and overwhelming for many. With the right support and guidance, pre-retirees can prepare themselves financially and mentally for the next chapter of their lives.
Financial advisers can play a crucial role in assisting pre-retirees with the complex financial decisions and planning required to achieve their retirement goals. By offering tailored advice and solutions, potentially including a transition to retirement strategy, financial advisers can help clients gain confidence and peace of mind, ultimately enabling them to enjoy a fulfilling and financially secure retirement.
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