Obviously no-one ever wants their retirement savings to fall in value. But for many superannuation members this is their post January 2020 reality.Join our newsletter
Market downturns impact the underlying tax components of accumulation and pension accounts differently.
When an accumulation account reduces in value because of investment losses, the loss reduces the taxable component first. This is because the tax free component is worked out using a specific formula (ie adding up the tax free component of any rollovers together with all the past non-concessional contributions, downsizer contributions etc and deducting the tax free components of lump sum benefit payments, pensions that have been commenced etc). The taxable component is “the rest of the balance”. If the balance goes down because of negative investment earnings, the tax free amount determined via the formula does not change and hence the full impact flows through to the taxable component.
In pension accounts, on the other hand, investment losses (and gains) are shared proportionately between the two tax components. The proportion is worked out when the pension starts and is generally locked in for the life of the pension.
Members with large tax free components mixed into their superannuation balance would therefore generally prefer they were in accumulation phase while markets are falling and in pension phase during the recovery.
That presents a number of important considerations during the current upheaval for people in this position (ie their balance has a large tax free component):
- Where their balance is still
in accumulation phase, they may wish to consider starting a pension before
markets recover to “lock in” a high tax free proportion. Of course, this will
only be relevant for those who are actually eligible to start a pension and
haven’t done so. Once upon a time this would have been a very small group.
But since the major tax changes in 2017, transition to retirement income
streams have become far less popular with many members now delaying starting
a pension until they have actually retired. The current environment is one
where a transition to retirement income stream may actually have more value
than first thought.
- Those who fail to meet the
minimum pension requirements for 2019/20 may see a small silver lining in
that they can re-calculate the tax free/taxable proportions of their pension
at 30 June 2020 when they “re-start” their pension. The tax free proportion
is likely to increase as the balance will be treated as if it was in
accumulation phase during the significant market falls since January 2020. Of
course, this is rarely enough to compensate for the major negative impact of
failing to meet the minimum pension requirements (the fund loses its tax
exemption on income from assets supporting that pension).
- Additional care will need to be taken by those commencing pensions or rolling over to a new fund at a time when their accumulation account has fallen so much that in fact the balance is lower than the tax free amount determined using the formula. This might happen if, for example, an individual previously converted all their superannuation to a pension. In 2019/20 they made non-concessional contributions of $300,000 as well as their usual $25,000 in concessional contributions. The intention was to convert the combined amount to a pension on 1 July 2020. If the balance is now only $270,000 thanks to market falls, there are better steps to take rather than simply converting the full $270,000 to a pension and “closing” the accumulation account. Leaving a small amount behind (eg converting only $269,000 to a pension and leaving an accumulation account of $1,000) might make it possible for up to $30,000 of future concessional contributions to be classified as a tax free component. This is covered in more detail in the strategies section of our Heffron Super Companion.