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NEWS - PLANNING
How to retire and pay no tax
8/29/2005
There are many good reasons why you should pay lower taxes in your retirement years, maybe even the lowest taxes in your life. Not only is your gross income likely to be less than previous years but there are numerous strategies that help cut tax to next to zero once people quit work.
It is important to make the most of these opportunities. Most of us do not appreciate what it takes for investments such as superannuation to earn close to the income of a successful business owner, senior employee, professional or skilled worker at the peak of a career. Nor do we grasp the real value of income that keeps up with inflation until we get close to retirement.
Getting a grip on these financial realities can be a daunting prospect but careful planning just before retirement and during its early years will reduce tax at this critical time. Smart Money has found five strategies to make the most of the tax rules that govern retirement and investments.
The potential benefits depend on whether you have the money and the inclination to take advantage of tax concessions designed to boost retirement savings. They will also depend on whether you have assets to convert into retirement savings - such as a business you can sell tax-free using small-business tax concessions or even a business profit you can contribute tax-free to superannuation. Your options are also influenced by your financial obligations - whether you still have a mortgage to pay or children attending university.
"Having a business that you can sell when you retire can be fantastic for your savings from a tax perspective.
If your business can provide you with super as well, you can have the best of both worlds," says tax adviser Gordon Cooper of Cooper & Co.
Super from a business can act as retirement savings insurance just in case your business doesn't quite work out. This shows, says Cooper, that saving for retirement can be approached in many different ways at various ages.
For a young person, the smartest strategy may be to pay off a mortgage or buy a house that can be sold in the future to add to retirement savings in superannuation, says Cooper.
The older people get, the more sense it makes to build up your super. At the top of the list of immediate pre-retirement strategies is maximising superannuation contributions - an attractive strategy for everyone since the July 1 abolition of the superannuation surcharge for high-income earners.
Before July 1, contributions to super by a high-income earner were reduced by 27.5 per cent due to the standard 15 per cent contributions tax and the 12.5 per cent surcharge. Now only the 15per cent contributions tax is charged. This means that for everyone, 85¢ of every super contribution dollar will go towards retirement savings.
It also means that if you're over 50 and can afford to maximise super with the highest possible tax concessional contributions over the next 12 months, your superannuation could increase by $85,500 after tax from contributions alone.
The over 50s have the highest tax concessions available to them for super contributions. The maximum tax concessional super contribution someone over 50 can make or salary sacrifice from wages (which could be income from your own business) is just under $100,600.
If the $100,600 was your entire taxable income, it would face tax plus the Medicare levy of $32,340 as ordinary income. As a super contribution, the tax would be cut by about $15,090 this year.
The next best strategy guaranteed to reduce your retirement tax is planning well in advance to take your super as an income stream rather than a lump sum. This should always include an allocated pension.
Pre-planning pensions will allow you to use a number of strategies just before retirement, such as making a strategic lump sum withdrawal from super which is then re-contributed to create an income stream with a more favourable tax mix.
Having a super pension as part of your retirement income will allow you to enjoy not only the tax concessions these pensions offer but also to make the most of extra tax breaks for many retirees over the age of 65 on certain incomes.
These include the low-tax rebate for those who receive the government age pension, as well as the senior Australians tax offset (which has a wider application for independently funded retirees).
The low-income rebate provides a tax break for anyone on retirement income of less than about $27,500 and the seniors tax offset extends this to just under $40,000 for a single retiree and combined income of more than $62,000 for a retiree couple. A combination of super pensions plus the seniors tax offset currently allows a single retiree to earn up to $33,150 and a married couple a combined $58,350 and pay only the 1.5 per cent Medicare levy in the way of tax.
Superannuation pensions offer still more avenues to create tax-effective income in retirement. If super allows you to direct savings into shares that pay dividend imputation tax credits, a strategy most common among do-it-your-self funds, the value of these investments are turbo-charged by the imputation tax entitlements.
Investments within super that fund pensions are officially in a tax-free zone for both income tax and capital gains tax. If there is no tax against which to offset imputation credits, the credits become refundable. In other words that means their full value is added to superannuation pension investment earnings as a tax refund.
Every $100 of fully-franked dividends is enhanced by a little less than $43 of extra income in the form of a tax refund. "The refund of franking credits is probably one of the biggest things that the government has done for superannuation in the pension stage," says John Randall, a tax partner with Deloites.
Reproduced from the Australian Financial Review - 27 Aug 2005
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