When it comes time to retire, you want the transition to be smooth and stress free. Ideally, you will have had a strong plan in place, have reached your financial goals and be well positioned to start living your dream retirement.
But it’s important to arm yourself with some knowledge of how different income streams are taxed and how you can make tax work for you once you’ve retired.
It’s well recognised that superannuation is a highly effective environment for retirement wealth building. Unlike personal investments that are subject to normal marginal tax rates, superannuation has a low 15% tax rate on concessional contributions and no additional tax placed on non-concessional contributions. This means boosting your superannuation funds during your working life can be extremely beneficial. And when it comes time to relax into retirement, there can be even more tax benefits.
Tax in super: taxable vs tax-free components
Within your superannuation there are both taxable and tax-free components.
The taxable portion comprises your concessional contributions, including employer contributions, salary sacrifice and personal contributions that you have claimed a tax deduction on when putting them into super. It also includes any investment earnings made by your super, such as dividends or interest payments, while your account is in accumulation phase.
The tax-free component is your non-concessional or ‘after-tax’ contributions and any government co-contributions you have received.
The amount of tax you could pay on your retirement income depends on these components, your age and the type of income stream you choose to utilise.
Different age brackets
For the majority of Australians, withdrawing funds from superannuation will be tax-free once you reach 60 years of age.
If you are between 55 to 59, you will pay tax according to the proportions of the taxable and tax-free components of your super. The tax-free funds are just that – tax-free; however, your taxable portion is generally subject to your marginal tax rate less a 15% tax offset.
If you are 55 or younger, your super is usually only accessible if you are permanently incapacitated. In this instance, you will be taxed as per the 55 to 59 age bracket.
Your income could be taxed differently again if your super is in a defined benefit super fund. Defined benefit funds are complex and each have different rules, so we recommend discussing your personal situation with a professional financial adviser before considering any withdrawals.
Income stream or lump sum
There are two different ways you can withdraw your super – as a regular super income stream or in a lump sum. And again, the type of fund and the chosen withdrawal process can affect how your income is taxed.
If you are 60 years or over and your super is held within a standard super fund, you won’t pay any tax on a structured income stream or a lump sum withdrawal, regardless of the separate taxable and tax-free components within your account.
If you are under 60 but have reached your preservation age, and you commence your super income stream, you will be taxed according to the components within your fund as outlined in the different age brackets above.
A lump sum withdrawal will be tax-free if you withdraw up to the low rate cap – which is $215,000 for the 2020-21 financial year. If you choose to withdraw an amount above this threshold, you will generally be subject to either 17% tax (including the Medicare levy) or your marginal tax rate, whichever rate is lower.
If you access a lump sum from your super before you have reached preservation age, you will pay 22% (including the Medicare levy) or your marginal tax rate, whichever is lower.
Transition to retirement
Once you have reached preservation age, you also have the option of a transition to retirement income stream (TRIS). Your preservation age will be between 55 and 60, depending on when you were born, with anyone born after 1 July 1964 having a preservation age of 60. A TRIS allows you to access a portion of your super while you are still working.
Under this system, you can withdraw up to 10% of your super balance each financial year. The tax is applied in the same method as outlined under the different age brackets. If you are over 60, your income will most likely be tax-free, and if you are under 60 it will depend on the component breakdown.