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What is the income swap strategy
Who can use the income swap strategy
How does the income swap strategy work
An example of the income swap strategy
An example with catch-up contributions
Downsides to the income swap strategy
Tips
What is the income swap strategy
This strategy is used by every financial planner, but is unheard of by almost everyone else, which means that those with more wealth use it to pay less tax while those who can’t afford a financial planner miss out. So, I’ve been eager to write about it and even the playing field.
The income swap strategy is where you contribute to super and simultaneously draw from super. The result is a boost to your super balance through tax savings without foregoing any of your take-home pay.
If you can access your super while you are still earning enough income to pay tax and if you are not already maxing out your concessional contributions, you’re missing out on free money by not using this strategy.
Who can use the income swap strategy
This strategy is for those aged 60 to 74 who are still working.
More specifically, it is for anyone who can access their super, pays income tax, and is eligible to make concessional contributions.
Accessing your super
You may think that you cannot access your super until you retire, but this isn’t the case.
To get unrestricted access to your super, you must meet a full condition of release, such as retiring, ceasing gainful employment after age 60, or reaching age 65. However, there is also a partial condition of release, where you are still working and over 60, which allows you to access up to a maximum of 10% of your super per year using a Transition to retirement (TTR) pension.
Personal income tax
Since 15% tax is taken by your super fund for concessional contributions, your marginal tax rate will need to be above 15% for this to work.
A taxable income between $21,884 and $45,000 means a marginal tax rate of only 19% and there is hardly any benefit.
A taxable income above $45,000 will mean a marginal tax rate of 32.5%, which is where you start to see the real benefits of this strategy.
Who is eligible to make concessional contributions
Anyone under age 75 can make personal concessional contributions, but if you are over 67, you must satisfy the work test or work test exemption to claim a tax deduction on personal contributions for it to become a concessional contribution (and it must be a concessional contribution for this strategy to work).
Concessional contributions also have a cap of $27,500 p.a., which includes employer contributions, but you can also make use of unused previous years’ contribution caps.
How does the income swap strategy work
Essentially, at the same time that you draw from super, you make voluntary concessional contributions to your super, which is then taxed at 15% instead of your marginal tax rate and the tax savings boosts your super.
Let’s say you are earning $80,000 and therefore are on the 34.5% marginal tax rate (including the 2% Medicare levy). You compare a couple of options that you have with $10,000 of that income:
- Continue doing nothing and pay 34.5% tax, and ending up with $6,550 in after-tax income to spend
- Contribute it to super concessionally and pay only 15% tax, ending up with $8,500, and then draw out the $6,550 that you would have had in option one. You can also do it the other way around if you don’t have access to the cash to contribute.
Another example
Example: 80k p.a., 100k available in super to move to a TTR pension.
- Go to paycalculator.com.au and change annual salary to $80,000 and look at the take home amount in green. In this example it is $61,933.
- Click on “superannuation” to expand that section and add in Salary Sacrifice Superannuation and continue increasing the amount until the take home amount is $10,000 less than the above amount. So $51,933. The salary sacrifice amount in this case ends up being $15,312.50
- Ensure you have the capacity to make at least this much concessional contributions. Otherwise, lower it to your maximum, and note the maximum in place of $15,312.50 and the withdrawal amount as the difference between the showing figure and $61,933.
- You can go and start a TTR pension to withdraw the withdrawing amount ($10,000 p.a. in this example).
- Ask your employer to set up salary sacrifice for the salary sacrifice amount ($15,312.50 in this example).
The steps to the income swap strategy are as follows:
1. Contribute to super
Make a voluntary concessional contribution (this can be through either personal contributions and claiming the tax deduction yourself, or through salary sacrifice). The annual concessional contribution cap is $27,500, and that includes your employer contributions. Although you may also have unused concessional contributions from previous years that can also be used.
2. Open a TTR account (or an account-based pension)
As mentioned above, there are three full conditions of release, but for this strategy, you will likely still be employed, so you may not meet a full condition of release before the age of 65. Luckily, there is also a partial condition of release you can get up to a maximum of 10% of your super per year by using TTR pension. If you meet a full condition of release (e.g., you previously ceased gainful employment after the age of 60), you can access as much of your super as you like.
3. Withdraw from super
Taking your original take-home pay amount will mean leaving you with the same personal after-tax income.
** Move step #1 to the end if you don’t have access to the cash to contribute.
The tax savings from doing this have then been added to your super, boosting your retirement savings without costing you anything or reducing your take-home pay.
An example of the income swap strategy
Let’s say the following applies:
- age 60 (and, therefore, reached preservation age)
- still working (and have not met a full condition of release but have met a partial condition of release)
- $80,000 taxable income
- employer contributes $10,000 p.a. to your super (let’s go with round figures)
Here is an example of the strategy in play. The left side (“Without ISS”) is without the Income Swap Strategy and the right side is with it.
The highlighted colour and the notes on the right column should simplify it.
| Description | Without ISS | With ISS | ||
|---|---|---|---|---|
| 1 | Pre-tax income | $80,000 | $80,000 | |
| 2 | Employer super contribution | $10,000 | $10,000 | |
| 3 | Concessional contribution cap remaining | $17,500 | $17,500 | |
| 4 | Personal super contribution | $0 | $17,500 | * Additional personal super contribution |
| 5 | Taxable income | $80,000 | $62,500 | * The reduction in taxable income |
| 6 | Tax payable | $18,067 | $11,967 | * Personal tax payable is far lower |
| 7 | Take-home pay after tax | $61,933 | $50,533 | * Take-home pay is also lower |
| 8 | Shortfall in take-home pay | $11,400 | * Shortfall in the cash you take home to live on | |
| 9 | Super balance increase | $10,000 | $27,500 | |
| 10 | Tax on super contribution (15%) | $1,500 | $4,125 | |
| 11 | Net super balance increase | $8,500 | $23,375 | * Super balance increase (after contribution tax) |
| 12 | Super withdrawal to cover take-home pay shortfall | $11,400 | From step 8 | |
| 13 | Net super balance increase after shortfall withdrawal | $11,975 | * Super balance increase after take-home shortfall covered by super withdrawal |
|
| 14 | Total cash taken home | $61,933 | $61,933 | * Take-home cash is the same |
| 15 | Total additional super | $8,500 | $11,975 | |
| 16 | Additional super from using the strategy | $3,475 | * Tax savings |
* Important note – you must be able to withdraw the required amount from your super for this strategy to work. If you have met a full condition of release, you can withdraw as much super as you like. However, if you have only met a partial condition of release as described above, you can only withdraw from your super by moving part or all of your super to a TTR pension account, and a TTR pension account has a maximum withdrawal amount of 10% of the balance per financial year. So in the above example, you could only replace the shortfall in take-home pay of $11,400 if you moved $114,000 to a TTR account.
An example with catch-up contributions
In this scenario, the same person as above has unused concessional contributions from previous years of $20,000, which means they can contribute even more into super and boost their retirement savings with even more money, again, without having sacrificed their net income to live off.
| Description | Without ISS | With ISS | ||
|---|---|---|---|---|
| 1 | Pre-tax income | $80,000 | $80,000 | |
| 2 | Employer super contribution | $10,000 | $10,000 | |
| 3a | Concessional contribution cap remaining | $17,500 | $17,500 | |
| 3b | Unused concessional contributions from previous years | $20,000 | $20,000 | * Differs from the above example |
| 3c | Concessional contribution cap remaining | $37,500 | $37,500 | * Differs from the above example |
| 4 | Personal super contribution | $0 | $37,500 | * Additional personal super contribution |
| 5 | Taxable income | $80,000 | $42,500 | * The reduction in taxable income |
| 6 | Tax payable | $18,067 | $5,017 | * Personal tax payable is far lower |
| 7 | Take-home pay after tax | $61,933 | $37,483 | * Take-home pay is also lower |
| 8 | Shortfall in take-home pay | $24,450 | * Shortfall in the cash you take home to live on | |
| 9 | Super balance increase | $10,000 | $47,500 | |
| 10 | Tax on super contribution (15%) | $1,500 | $7,125 | |
| 11 | Net super balance increase | $8,500 | $40,375 | * Super balance increase (after contribution tax) |
| 12 | Super withdrawal to cover take-home pay shortfall | $24,450 | From step 8 | |
| 13 | Net super balance increase after shortfall withdrawal | $15,925 | * Super balance increase after take-home shortfall covered by super withdrawal |
|
| 14 | Total cash taken home | $61,933 | $61,933 | * Take-home cash is the same |
| 15 | Total additional super | $8,500 | $15,925 | |
| 16 | Additional super from using the strategy | $7,425 | * Tax savings |
* Important note – you must be able to withdraw the required amount from your super for this strategy to work. If you have met a full condition of release, you can withdraw as much super as you like. However, if you have only met a partial condition of release as described above, you can only withdraw from your super by moving part or all of your super to a TTR pension account, and a TTR pension account has a maximum withdrawal amount of 10% of the balance per financial year. So in the above example, you could only replace the shortfall in take-home pay of $24,450 if you moved $244,500 to a TTR account.
Downsides to the income swap strategy
There really aren’t any downsides to this strategy if you use it from age 60. You get to reduce your tax, which goes towards your retirement nest egg, and it costs you nothing.
The only things to look out for are:
- If you have reached preservation age but are under 60, there may be personal tax on income received from your super.
- If you don’t actually need your current full income, leaving it in super may be more beneficial.
- If you are saving up your concessional contributions to use the carry-forward strategy for a large, lumpy capital gain, such as the sale of an investment property, you may wish to defer additional concessional contributions to be used in a year where you expect to have additional taxable income that could result in a higher marginal tax rate being applied. Using this strategy may reduce the effectiveness of that strategy.
- If you are eligible to convert to an account-based pension account instead of a TTR pension account, that will offer the same benefits but with tax-free earnings within your account-based pension account. This isn’t exactly a downside, so much as a tip that there is an improved version of the strategy available.
Tips
Tip 1 – keeping your accumulation account open for insurance and contributions
Moving your entire accumulation balance across to a TTR pension account or an account-based pension account will close your accumulation account. But you will need your accumulation account open to accept future contributions and to keep your life insurance in place, so you will want to leave $10,000 or more than enough to cover the premium in there.
Tip 2 – do not move unrestricted non-preserved amounts to your TTR account (this is already accessible)
If you made voluntary contributions before 1999, you may already have access to that part of your super. Check your super statement for the phrase “unrestricted non-preserved” and if you have any, don’t move that to your TTR account as you can already access it, and, additionally, those are required to be the first amounts that will be released from a TTR pension account’s payments, so it would be wasting the abilility to maximise your access to your super. Instead, keep your unrestricted non-preserved amounts in an accumulation account and move the preserved amounts over – you are allowed to choose which parts to move over.
Tip 3 – taxable income dropping below $45,000 may not provide the greatest benefit
If you happen to have enough unused concessional contributions such that it would drop your taxable income below the $45,000 mark (where your marginal tax rate drops down to 21% (including the 2% Medicare levy), it may be prudent to save that additional money and contribute it the following financial year. This is because a 21% marginal tax rate is not much of a tax savings above the 15% contribution tax taken out of super, and you may benefit more with a higher marginal tax rate in the next financial year.
Tip 4 – be aware of the effect of an age gap between partners
If there is an age gap between you and your partner, the younger spouse could potentially use this strategy before preservation age by splitting their contribution to their spouse’s super for access (provided the older spouse is still working and between preservation age and 65 to meet the eligibility rules). However, weigh this up against any desire to reduce the older spouse’s super for the sake of age pension benefits (see contribution splitting for more info).