Which pension funds pay tax
Few weeks ago, I was talking about: “How is tax calculated in retirement” If you missed it, here is the link.
Then I received an email from Aboud, who asked me this question:
According to your statement on the video there is No Tax on the $50K from the Superannuation Income Stream!?
However, in my situation I am retired already a few years back and get approx. $46k p/a from my Commonwealth Superannuation. The payment called Capped Defined Benefit Superannuation Income Stream, And it is fully taxable, I wonder why my income stream is taxable and the guy SVEN in your video income stream is tax free?
Please clarify the difference between the 2 income streams.
First of all, thank you Aboud for so well defined and detailed question. It is much easier to answer such a question than the one that is of generic nature.
So today I will try to answer Aboud’s question and we will continue discussing retirement income streams in Australia.
As we all know, and as per my explanation in: “How is tax calculated in retirement”, after turning our superannuation savings into a retirement income stream, generally there is no tax to be paid on income received. Most income streams do not pay any tax on payments made to members, on lumpsum withdrawals or on earnings made within the fund.
But this rule does not apply to all income stream, and if you used to work for a government in any capacity in the past, it is very likely that you might have been provided with the compulsory superannuation that were defined benefit funds such as for example:
- Commonwealth Superannuation Scheme (CSS) fund,
- Military Superannuation and Benefits Scheme (MSBS),
- Public Sector Superannuation Scheme (PSS),
- part of the UniSuper fund,
- WA-based Gold State Super and
- WA- based West State Super.
So, what is the difference between a normal accumulation superannuation account most of us have and a defined benefit super provided to the employees of the Commonwealth government and most people working in the public sector?
Well, the accumulation superannuation account is the account that accepts different types of super contributions. Then the balance is invested according to members’ choice and the outcome depends on market returns and earning made over time.
Defined benefit funds are different as their final benefit will depend on other factors such as years of service or the final average salary or both. Therefore, the final outcome is pre-determined and calculated based on a certain formula, rather then investment outcomes.
You might think that this is a fantastic superannuation outcome, that the government invented for themselves. And in most cases this is true, apart from one tiny detail – tax.
I have been talking about superannuation a great deal on this channel, and I have explained different types of contributions you can make to super. Therefore, you should know by now that there are two types of contributions:
- Concessional – otherwise known as pre-tax contributions, where someone claimed a tax deduction and
- Non-concessional – otherwise known as personal after-tax contributions or “tax-free” contributions.
Well, a defined benefit super and pension account will very often have what we call an un-taxed element, and this is where the issue of the tax that Aboud is mentioning in his email.
Why is this an issue?
In the world of employment outside of the government or public sector, when an employer contributes to super, the fund automatically pays the concessional contribution tax of 15% to the ATO.
However, this has not been happening in defined benefit super funds. When working for the government and in any public sector, your employer (the government) would make those contributions, but somehow forgot to pay the tax.
Well, let’s be honest the government hasn’t really forgotten, but most of those contributions were done on the piece of paper, as the accounting calculations only, so there was no real money to pay the tax. That money has never been invested; it was just an accounting calculation to know how much the government owes you when you retire.
It was much easier to calculate that final benefit based on the years of your service or a multiple of your final salary.
Therefore, you have a situation that contributions were made (at least recorded), no contribution tax was had been paid over the years and once you got to your retirement your defined benefit super or pension has included an untaxed element.
So now, in your retirement, the Tax office wants to get their share of the lost tax. This is the reason why Aboud is taxed.
Therefore, if you are over the age of 60, retired and receive an income from a defined benefit pension, you might have all three components within your pension account. So now when your pension payments are made to you, there will be no tax to be paid on your tax-free and taxed component, just like any other pension account, but the tax will be charged on that untaxed element of your pension payments, which would be calculated at your marginal tax rate less a 10% tax offset, which is also subject to the Defined Benefit Income Cap.
Defined Benefit Income Cap is complicated and if you are affected in any way, make sure you search for the full advice, as superannuation caps are beyond the scope of a general advice of my newsletters.
Define benefit pensions are some of the best retirement income streams, as pension payments are guaranteed for life, and often might continue as partial payment for the life of your spouse, and income is paid irrespective of market returns. This is a huge benefit.
I hope Aboud I answered your question and questions of many other listeners that have a defined benefit pension.
These days it is unlikely that you have a choice of a defined benefit pension, this is such a high cost for the government, that those pensions have been removed and are no longer provided. However, you could instead be participating in a defined benefit super scheme, with no pension option available, but with the final benefit still calculated based on the formula, rather than market returns.
On retirement it is most likely you will be asked to move your full balance to a different super provider, but keep in mind there will be immediate tax consequences, therefore it is imperative that you receive the appropriate retirement advice to know how to structure your income stream considering tax, your future income needs and Age Pension if applicable.
By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement
