The tax-free retirement phase is the jewel in the crown of the super system. Getting your savings into it is as simple as starting a retirement pension, also known as a retirement income stream.
What many people don’t realise is that you don’t necessarily have to retire from the workforce to start a pension and start enjoying the tax-free benefits. And even if you are retired but have sufficient retirement income outside super, it can still be worth your while to start a super pension.
Barriers to action
How and when to start a pension is a question many people approaching retirement age have difficulty tackling, with eligibility criteria, rules and the required forms and procedures getting in the way of action.
With the benefit of tax-free investment earnings, income payments and the ability to contribute to super until age 75, starting a retirement income stream immediately after becoming eligible is a great deal for almost everyone, but there are some bumps in the road to watch for.
While other retirement income streams are available, we focus here on simple account-based pensions because they remain the most popular and widely available choice.
When am I eligible to start a retirement pension?
The three most common triggers to unlock the retirement phase are:
- Turning 65
- Being at least 60 and permanently retired
- Leaving a job after turning 60, even if you will return to work.
If you leave a job after your 60th birthday but are not permanently retiring, the super you have accumulated up to that point is accessible and can be used to start a retirement pension. Any future contributions from you and your employer(s) can’t be withdrawn in cash or used to start a retirement pension until you leave work again or turn 65, whichever comes first.
It is also possible to start a retirement pension if you become eligible to access your super early due to permanent incapacity or you’re using a super death benefit you have become entitled to after the death of another person. However, tax may apply to the income payments if you are under 60.
There is also the option to start a transition-to-retirement pension if you have turned 60 but are not retired and have not left a job since your 60th birthday. Importantly, investment earnings in transition-to-retirement pensions remain taxable.
Reasons for starting a retirement pension
Tax-free investment returns
Before you start a pension, your super is invested in the accumulation phase, where all investment earnings are taxable at the rate of 15%.
When you transfer your balance into a pension account, all future investment earnings (interest, dividends, rent and capital gains) are received tax-free. Any amount you leave in an accumulation account continues to generate taxable earnings.
Because no taxes are deducted, the investment return for the same assets in the retirement phase is higher than in accumulation accounts when returns are positive. Conversely, in negative years, pension accounts can experience a larger fall in value because they can’t use losses to reduce tax.
If you have a self-managed fund (SMSF), the removal of tax on returns can be even more important, especially when it comes to capital gains tax and the timing of asset sales.
Importantly, if an SMSF holds interests in both the retirement and accumulation phases, decisions must be made about the method to determine which income of the fund is exempt from tax.
In good news for those of us without an SMSF, large funds can also benefit from delaying asset sales until retirement phase. Some funds pass this benefit on to members in the form of a bonus credited to your account when you choose to start a pension.
Unlimited tax-free income
For most people, money withdrawn from super after turning 60 is entirely tax-free, non-assessable income. The exception is if your account is in an untaxed super fund and contains an untaxed element. You may be a member of an untaxed fund if you have worked for the state or federal government.
Simple account-based pensions in retirement phase have no maximum withdrawal, but you must withdraw at least the minimum mandated amount each financial year, which is 4% of the balance when you’re under 65 and 5% when you’re 65–74. The minimum continues to increase as you age.
If you don’t need the income for spending, it can still be worth starting a pension and contributing it back to your super account. You can:
- Claim a tax deduction for your contributions if you still have taxable income
- Make after-tax (non-concessional) contributions and generate a co-contribution, or simply avoid depleting your super savings by spending withdrawals you don’t need.
Reasons for holding off
Before taking the leap, there are some roadblocks to consider.
Transfer balance cap
The transfer balance cap puts a limit on the amount you can transfer into retirement phase. The general cap sits at $1.9 million at the time of writing and will increase to $2 million on 1 July 2025 due to indexation. The cap will continue to be indexed in the future in increments of $100,000.
Starting a retirement pension uses some of the cap and impacts how your personal cap will rise in the future. The more of the cap you consume now, the less future indexation you will be entitled to. People with high balances may wish to delay starting their first retirement phase pension until after a rise in the cap to maximise the amount that can be moved into this tax-free environment, particularly if further significant contributions are planned.
Centrelink assessment
While you are under 67, any super held in accumulation phase is not assessed in Centrelink’s means tests. When you start a pension, the full balance becomes assessable.
If you or your partner are receiving Centrelink payments, starting a pension while under 67 could have a significant impact on your entitlements.
After turning 67, all super is assessable both in the accumulation and retirement phase, and starting an account-based pension will not change the rate of Centrelink benefits. However, lifetime income streams are assessed differently and can help increase entitlements, including the Age Pension.
Fees
If you will be continuing to contribute to super after starting a pension, you will need to maintain a separate accumulation account for those contributions. Paying two sets of administration fees could reduce the benefit of starting a pension, particularly if pension fees are significantly higher than for accumulation accounts.
3 case studies
Starting a super pension sooner rather than later can be a profitable strategy in many circumstances. The following case studies focus on an Age Pensioner, a self-funded retiree with no need to tap into super just yet, and a person over 65 who’s still working.
For the purposes of this article, we assume pension accounts generate investment earnings of 0.7% per year more than comparable accumulation accounts (see assumptions at the end of the article).
1. Age pensioner reluctant to draw on super
Geoff is single and retired, aged 70, and living on the Age Pension. He has $300,000 in super that he draws lump sums from as needed when unexpected expenses come up.
Geoff hasn’t started a pension because he thinks of his super as a nest egg and doesn’t want to ‘eat away’ at its value.
Using our estimate of 0.7% additional investment earnings per year in the retirement phase, Geoff could expect $2,100 in additional investment growth on his balance in the first year by moving his entire balance into an account-based pension. He would be required to withdraw $15,000 if his account is open for the entire financial year (5% of the balance).
Until he turns 75, Geoff is eligible to make non-concessional (after-tax) contributions to super. He can consider investing any required withdrawals he doesn’t need for spending in a new super accumulation account, or an investment outside super.
In future, Geoff can use any funds that build up in a new accumulation account to start a second pension or consolidate his existing pension with the accumulation account to start a new pension with the combined amount. These steps are needed if Geoff wants to get his additional contributions into the tax-free retirement (pension) phase because contributions can’t be made into a pension account.
2. Retiree with no need for income
Giovanni is 62 and retired. His wife, Sophia, is still in the workforce and earns enough to support them both, so he hasn’t thought about drawing on his super.
Giovanni has a balance of $800,000. Assuming an additional return of 0.7%, he may expect his investment earnings to be $5,600 higher for the year if he chooses to use his entire balance to start a pension. His required minimum withdrawal for the first year, assuming a pension is started on 1 July, would be $32,000 (4% of the balance).
Giovanni can choose when to receive the required withdrawal from his pension account. For example, he may select an annual payment in June to maximise the time his money remains invested in the pension exposed to tax-free growth before he makes a withdrawal.
Since this tax-free income is not required for spending, the couple can use it in the most beneficial way for them, based on their personal circumstances.
For example, Sophia may be able to increase her personal concessional contributions to super to reduce her income tax bill, replacing taxable income from her work with tax-free income from Giovanni’s super.
If Sophia is already maximising tax-effective concessional contributions, the couple may choose to use the withdrawals to make non-concessional contributions to her super, or to a new accumulation account Giovanni opens in his name.
3. Reaching 65 and continuing to work
Carol has just turned 65 and plans to continue working until she turns 70, when her mortgage will be paid off. She has $200,000 in super, which is around the median for a woman her age.
Carol works as a sole trader and earns $90,000 per year before tax. For the last five years she has been making personal super contributions of $10,000 per year and claiming a tax deduction to boost her super and save on tax. Her future goals are to maximise her super balance and minimise tax for her adult children if they inherit her remaining super balance after she passes away.
Since she has been contributing less than the annual concessional cap, Carol has unused concessional cap space from the past five years of $67,500. Her total super balance on the last 30 June was below $500,000, so this makes her eligible to use the unused cap space in future years.
After seeking some personalised advice, the steps Carol plans to take are:
-
- Withdraw the entire current super balance of $200,000 as a lump sum and recontribute it to super as a personal non-concessional amount. This will convert the balance to a tax-free component that can be passed to beneficiaries tax-free. The contribution is above the annual non-concessional cap of $120,000, but is possible thanks to the bring-forward rule. The bring-forward period is made up of the financial year the first contribution is made and the following two financial years.
- Immediately after this contribution, start a retirement phase pension with the entire balance, set to draw $23,500 in May (to maximise the time the full balance will generate tax-free earnings).
- Tax-free earnings on her pension account, generating additional growth of approximately $1,400 in the first year (0.7% of $200,000). This benefit will increase in subsequent years as her pension balance increases.
- Additional annual net tax savings of $6,125 through increased deductible super contributions (paying $5,250 super contribution tax instead of $11,375 income tax on the additional $35,000 contributed to super). This saving will be reflected in a higher total super balance since Carol is withdrawing less than she contributes.
- Certainty that her adult children will not pay tax if they inherit money from her super after she passes away.
- Early in the following financial year, withdraw the balance of the accumulation account as a lump sum and recontribute it as a non-concessional amount. The account’s value will be approximately $38,250 after the contribution tax is deducted from the contribution. This process converts the amount to the tax-free component.
- Roll over (commute) the balance of the pension account into the accumulation account that now contains only the tax-free component. The pension is already a 100% tax-free component since it was converted in step 1.
- Use the total combined balance in super to start a new pension set to draw $23,500 in the following May.
The steps from 4–7 can be repeated for each of the following years that Carol plans to work.
The benefits for Carol include:
- Tax-free earnings on her pension account, generating additional growth of approximately $1,400 in the first year (0.7% of $200,000). This benefit will increase in subsequent years as her pension balance increases.
- Additional annual net tax savings of $6,125 through increased deductible super contributions (paying $5,250 super contribution tax instead of $11,375 income tax on the additional $35,000 contributed to super). This saving will be reflected in a higher total super balance since Carol is withdrawing less than she contributes.
- Certainty that her adult children will not pay tax if they inherit money from her super after she passes away.
Need to know
A strategy like Carol’s is complex to design and implement. While free tools like paycalculator.com.au can help you explore the after-tax outcome of super contribution strategies and education from services like SuperGuide is available to explain rules and options, you may need professional personal advice. An adviser can not only come up with the optimal strategy for you (and your partner if applicable) but will help you with all the required paperwork and monitor your progress, including ensuring you remain eligible to follow the plan.
For example, in Carol’s case, she must:
- Meet the work test to claim a tax deduction for personal super contributions after turning 67
- Ensure her notice of intent to claim a tax deduction for super contributions is received and processed before withdrawing that contribution as a lump sum.
- Maintain a total super balance under $500,000 on each 30 June to use the carry forward of concessional cap space in the following financial year
- Ensure her total non-concessional contributions remain below $360,000 during her three-year bring-forward period.
Super rules can be difficult to understand and change frequently. Your super fund may have a financial planning service that can assist you, or you can refer to our national list of independent advisers.
Assumptions
To measure the difference that removing tax on returns could be expected to make we checked the 10-year average returns for the top five super investment options in Chant West’s ‘Balanced’ (41–60% Growth assets) category to December 2024 and compared with the option of the same name in the funds’ account-based pensions.
The average difference in annual return was 0.7% in favour of pension accounts.
An additional 0.7% annual return means $700 more per year added to your account for each $100,000 invested. You can check the average difference in returns for your chosen investment option(s) in your super fund’s accumulation and pension accounts.
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