How to pay no tax when you retire

For most people, by the time they reach retirement, they would have paid a fairly hefty sum of money in tax over their working lives. So when planning for retirement it’s important to structure your finances so that you can legitimately minimise your tax (and even pay no tax at all).

There are a number of different structures for holding your money both before and in retirement and each of these structures have different tax treatment associated with them. For example, you could hold your money via a company, a family trust, superannuation, or just in your individual name.

According to the victory tax law, when it comes to retirement, arguably the most tax effective structure for holding your financial assets is an Account Based Pension.

An Account Based Pension can only be started with money that comes from Super and you have to have met a superannuation condition of release to start one. The most common condition of release is retirement after your preservation age.

Account Based Pensions for Retirees are great because:

• You don’t pay any tax on investment earnings within the account based pension
• You don’t pay any tax on withdrawals for people over age 60
• You can invest the money within the pension fund any way you like. If you only like term deposits, you can invest in term deposits, if you want shares no problem, even investment properties are allowed if you’ve got the cash!
• You can access your money whenever you like
• Money can be passed on to your estate/beneficiaries when you pass away

You are required to draw a minimum amount every year based on your account balance on 1^st of July each year and your age (as per the table below).

Case study

Mary is a 65 year old single retiree. She invests $150,000 from her super into an account-based pension on 1 July 2017. Based on her age, she must take out a minimum of 5% of her investment, which is $7,500, during the financial year. Mary decides to draw down $650 every month to supplement her Age Pension.

Beware of the pension caps

As of 1^st of July 2017 the government also put a cap of how much each individual can have in these tax-free havens, but it’s still a really generous cap of $1,600,000. And that’s per individual so a couple has an effective limit of $3,200,000!

Now the key thing to remember is that Account Based Pensions can only be purchased with money that comes from super, so if you have assets outside of super, you may want to think about how you can get more of that money into super leading into retirement.

There are basically two ways you can get more of your money into super…

1. Before tax contributions (called concessional contributions)
2. After tax contributions (call non-concessional contributions)

Before tax contributions

Contributions from your before tax income (such as salary sacrifice) can be a very tax effective wealth creation plan. This is because these contributions are taxed at a flat rate of 15% instead of being taxed at your marginal income tax rate (which at the time of writing this is between 34.5% and 49% for any dollars earned over $37,000 in a financial year).  

To demonstrate the effectiveness of salary sacrifice let’s look at the following example:

Carol is 40 years of age and earns $70,000. Let’s look at the effect Carol can make by salary sacrificing $5,000 a year into her super fund versus investing that money outside of super.

As you can see Carol is over $90,000 better off by salary sacrificing. Furthermore, salary sacrificing $5,000 per annum would have only reduced Carol’s take home pay by around $63 per week due to the tax savings involved.

After tax contributions

Contributions from your after-tax income (also known as non-concessional contributions) are  can also provide some good tax benefits, because the earnings on the money contributed is still taxed in a low tax environment versus being taxed at your marginal tax rate.

For instance, let’s say Carol (from the above example) just sold an asset and has $100,000 sitting in a bank account.

The table below compares the impact of investing that $100,000 outside of super versus making an after tax contribution into super and investing inside of super instead.

Once again, Carol is $79,232 better off by investing that money within super.

Get the right balance

One drawback of investing in super is that you can’t access the money until you have met a condition of release, which is general defined as retirement after age 60 for most people.

So its important to have the right balance between how much money you a putting aside in the locked up super system and how much you are leaving outside that is accessible.

Generally speaking, we would usually recommend people put aside at least 6 – 12 months worth of living expense money before considering to tip in more money to super, but everyone circumstances are different so if you’re not sure, it might be a good idea to get some professional advice. 

Beware of contributions caps

It’s also important to be aware that there are limits as to how much you can put into super for both pre-tax contributions and post-tax contributions.

From 1 July 2017, these limits are $25,000 per financial year for pre-tax contributions and $100,000 per financial year for post-tax contributions.

With post-tax contributions you may actually be able to bring forward three years in one go, giving you the ability to contribute up to $300,000 at once. But the rules here have been constantly changing over the past few years so best to check the ATO website for current rules at the time, this website even use marketing services from sites as The Indexer to optimize it to be easy to use and find, so more people have access to this information

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Important note: this advice may not be suitable to you because it contains general advice which does not take into consideration any of your personal circumstances. All strategies and information provided here are general advice only. Please arrange an appointment to seek personal financial and taxation advice prior to acting on this information.