What are the Tax Rules?
The tax rules for your retirement income stream will depend on your age and the type of fund that is paying you the income stream.
Usually Tax Free
From 1 July 2007, if you are over age 60, the income payments you receive will be tax free if they are paid from a taxed super source or fund. Most retirement income streams are payable from taxed super funds - this means funds that are subject to tax on their income along the way. All account based income streams and most publicly available non account based income streams are payable from a taxed source (or fund).
The tax free status of your income stream applies regardless of how much income you derive. So theoretically, if you invested in an account based product you draw the whole amount out and not pay any tax on the amount. Also, because the amount is tax free you don't even have to include it in your tax return.
Payments under Age 60
From 1 July 2007, the taxable income from a superannuation income stream under age 60 will be determined by applying a 'proportioning rule'.
| Source of Income Stream Income | Assessable Component of Income |
|---|---|
| Proportion representing the Tax Free Component in the benefit | Nil - (effectively tax free income) |
| Proportion representing the Taxable Component in the benefit | Fully assessable - (subject to tax at the recipient's marginal tax rates although a 15% tax-offset may apply over age 55) |
- Note income streams from an untaxed source do not receive any tax offset under age 60.
- The Tax Free component of your superannuation benefit will generally comprise personal after-tax or undeducted contributions. In some case, certain other amounts are also included in the Tax Free component of a benefit.
For superannuation income streams that commence on or after 1 July 2007, this new proportioning rule involves a two-step process:
- Step 1 - Determine the proportion of the total superannuation benefit that is the Tax Free Component at the commencement date; then
- Step 2 - Apply this calculated proportion to all future income (and capital) payments that are made from the superannuation income stream.
Example
Sally, aged 57, purchases a superannuation income stream on 1 July 2007 with her total superannuation benefit of $500,000. Her income stream will pay her $2,000 per month. This superannuation benefit consists of the following tax components:
- Tax Free Component = $200,000; and
- Taxable Component = $300,000.
Using the proportioning rule, we can determine that the amount of income she will be able to receive on a tax free basis is:
-
Step 1 The proportion of Sally's superannuation benefit that is the Tax Free Component
= $200,000/$500,000 = 40% -
Step 2 The amount of income able to be received on a tax free basis
= 40% x $2,000 = $800 per month
Therefore the Taxable Component of Sally's $2,000 monthly income payment is $1,200.
Will I get a tax offset?
A tax offset of 15% is available to recipients who are aged less than 60 (but over preservation age) for income streams paid from taxed super funds.
The offset is 15% of the gross pension or annuity payment less the tax free portion where one exists. The following example explains the calculations:
$ |
|
|---|---|
| Gross Pension or Annuity | 20,000 |
| Less Tax free amount | (4,000) |
| Assessable pension or Annuity | 16,000 |
| Tax on Assessable pension or Annuity (excluding Medicare levy) | 1,500 |
| Less Pension Offset @ 15% of $16,000 | 2,400 |
| Tax Payable | NIL |
*Note that the tax assessed in the above example has been simplified and there may be other taxation rebates applicable in many cases. Further, Medicare levy may be payable.
In this example, no tax would be payable on this part of the person's assessable income for the year and there would be an excess offset to use against any other tax payable.
Note. If we return to the previous example of Sally, she would be entitled to receive a tax offset of 15% x $1,200 = $180 per month since she is over age 55. From age 60, all of her income payments would be tax-free.
Excess Offset Usage
An excess offset arises where the pension or annuity offset nullifies any tax that would otherwise be payable on pension or annuity payments and the offset is greater than the total tax payable.
It is possible in these situations to offset the excess amount against tax on any other income that the person has in that year. The excess offset cannot be carried forward to the next tax year if it is not used this year.
Working out tax (untaxed funds)
Income streams payable from untaxed funds (e.g. Commonwealth Superannuation Scheme) are generally known as 'defined benefit' super pensions. These types of pensions are usually similar to other lifetime income streams in that payments are generally made for your lifetime and in some cases, also the lifetime of your spouse.
With defined benefit super pensions, some part of your income stream payments may be considered to be tax free. The balance of any income payment will be considered assessable and hence taxable income.
The calculation of the 'tax free' amount depends upon a range of factors, including whether or not the income stream started before 1 July 2007 and whether or not you are age 60 or more. Generally, the tax free component will represent the total amount of any undeducted contributions that were made to your fund. These are contributions made to a fund where no tax deduction has been provided for the contributions. They are also referred to as contributions you make from after-tax dollars.
If you are aged 60 or over, generally you will be eligible to obtain a 10% tax offset on the amount of any taxable income payments you receive from a defined benefit pension.
Example
Mary is a 65 year old public servant who decides to retire in July 2007. Mary will receive an annual superannuation pension of $35,000 p.a. from her public sector super scheme.
Mary also found out that $5,000 of her pension income is considered to come from her personal after-tax contributions that she made prior to retirement (using the proportional method illustrated previously).
Since $5,000 of Mary's $35,000 pension is deemed to come from her after-tax income, she would only have taxable pension income of $30,000. The amount of $5,000 would be paid to Mary tax free.
Mary would also receive a tax offset of 10 per cent of $30,000 (or $3,000). This can be used to offset the amount of tax payable by Mary (depending on her circumstances).
Working out tax (non-super funds)
The tax treatment of income stream payments payable from annuities purchased with non super money is slightly different.
There are a few steps involved in working this out, and a few technical terms you need to know some more about.
Step 1 is to work out your Undeducted Purchase Price (UPP).
Where you have purchased your income stream with other private savings (not 'superannuation money') the UPP will be equal to the purchase price of your investment.
Step 2 To determine the tax free amount (its technical name is deductible amount), the undeducted purchase price is divided by the relevant number.
For income streams which are payable for a life the relevant number will be the life expectancy of the recipient. For income streams payable for a fixed term, the number of years it is payable for will be the relevant number.
For a single person, her or his life expectancy factor will be used. For couples, the longest life expectancy of the couple will be used where the income stream has been set up to continue to a spouse in the event of the death of the purchaser.
Step 3 Is there a residual capital value? If the income stream you invest in will pay you back part of your capital at the end of the term, then this must be taken into account in the calculation of the tax free part of your income stream. This does not usually apply for income streams payable from untaxed funds.
Step 4 Do the following calculation:
Tax free amount = UPP less residual capital value ÷ Relevant number
Now that we have looked at the theory, let's look at some real life examples.
Where the undeducted purchase price (UPP) component is say, $100,000, and a single life pension or annuity is purchased by a 65 year old male, the calculation is as follows:
$100,000 ÷ 17.7 = $5,650
This assumes there is no residual capital value involved.
In this case, $5,650 of the annual income payment will be tax free. Normal marginal tax rates will be applied to any income payment in excess of the annual deductible amount. There is no specific tax offset that applies for non-superannuation income streams.