Karen and Steve, aged 58 and 62, are retiring on June 30. They have been contributing to super over their working lives and feel the time has come to reap the rewards of their hard work.
Karen would like to withdraw a lump sum of $100,000 and purchase an account-based pension with the remaining $400,000. Steve has decided to commence a pension with $750,000 and leave the remaining $50,000 in super.
Considering themselves fairly super savvy, they are stumped when it comes to the proportioning rule and how it affects their superannuation payments. Section 307-120 of the Income Tax Assessment Act 1997 (ITAA97) says that a superannuation benefit may comprise a tax-free and taxable component.
Section 307-125 explains that the composition of these components is based on the proportion they represent of the total super benefit. For example, Karen’s benefit is comprised of 80 per cent taxable and 20 per cent tax-free components.
In order for the proportioning rule to apply to a superannuation benefit, a trigger event needs to take place after July 1, 2007. These are:
Ã¢â‚¬Â¢ Having an existing pension and being age 60;
Ã¢â‚¬Â¢ Having an existing pension and turning age 60;
Ã¢â‚¬Â¢ Commencing an income stream;
Ã¢â‚¬Â¢ Requesting a part or full withdrawal; or
Once a trigger event occurs, any subsequent lump sum withdrawals or pension payments paid from a superannuation interest are divided into the taxable and tax-free components.
Karen’s $100,000 lump sum withdrawal therefore will be made up of $80,000 taxable and $20,000 tax-free component.
For clients aged between 55 and 59 years, the tax-free component is paid tax-free. However, the taxable component is treated differently depending on the amount of that portion, as follows:
Less than $140,000 = 0 per cent
Over $140,000 = 16.5 per cent
In Karen’s case, the $100,000 withdrawal will be entirely tax-free.
When Karen commences a pension with her remaining funds, the benefit will again be divided proportionally between the taxable and tax-free components. Once commenced, the proportions remain the same for the life of the pension.
Assuming Karen receives a yearly income of $20,000, $16,000 will be taxable and $4,000 taxfree. The tax-free component is received tax-free and the taxable component will be included in Karen’s assessable income for the year and taxed accordingly. Karen will be entitled to a 15 per cent tax offset on the taxable portion of her pension ($2400).
Steve’s case differs slightly as his superannuation benefit will be divided between the accumulation and pension phases. According to the ITAA97 regulations, if a superannuation income stream commences, this is always treated as a separate superannuation interest for the purposes of the proportioning rule. Despite Steve being over 60 and therefore receiving the income stream taxfree, on commencement it too will be proportioned between the taxable and tax-free components in the ratio of 75 per cent taxable and 25 per cent tax-free.
Based on a $20,000 annual income, $15,000 will be taxable and $5,000 will be a tax-free component.
Any growth on the income stream will be proportioned between the components. On the other hand, any growth on the $50,000 accumulating in super will add to the taxable component only. Any concessional or non-concessional contributions Steve makes will also alter the proportions of taxable and tax-free components.
The significance of these proportions for Steve will only be realised upon his death.
At that time, Steve’s remaining pension benefit will be divided in the ratio of 75:25 and distributed to Steve’s beneficiaries. The benefit in accumulation phase will be proportioned based on the components at the time of death. Steve’s dependants will receive both the taxable and tax-free portions tax-free. However, any distribution to non-dependants will result in the taxable portion being taxed at a rate of 16.5 per cent.