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As you approach retirement, a crucial decision awaits about what to do with your superannuation benefits. That decision is even more complex if you also have significant assets outside super.
You may have built up investments outside super over your working life or you may have received a large inheritance you can’t put into your super account due to contribution caps. These situations could put you in a position where you don’t need to draw on your super, at least in the short term.
The decision then is whether you should commence an income stream from super or leave it the accumulation phase while utilising investment income outside super. (You could, of course, take the middle way and draw on both your super and non-super savings, but for simplicity we will restrict discussion to a comparison of the two main options.)
So, if you are undecided about whether to draw retirement income from a super pension or non-super investment income, we outline the key the pros and cons of these two options before looking at a case study.
Option 1: Leave super in the accumulation phase
Pros
Personal capital gains event
If you are about to have a significant capital gains event outside super (e.g. selling an investment property), then your marginal tax rate that financial year could be at the top end (currently 47% including Medicare). Say you were in receipt of pension income from super and you do not use that income and instead invest in your personal name, then the earnings on the investment will be taxed at 47% that financial year. However, if your super was still in the accumulation phase, then the earnings on that portion would be taxed at just 15%.
If you have more than the transfer balance cap (TBC) in super
Due to the transfer balance cap rules, from 1 July 2023 the most you can have in retirement phase super pension accounts is $1.9 million (up from $1.7 million previously). Any balance above this amount must be withdrawn or stay in accumulation phase.
Investment income outside super
If you have built a good asset base outside super, you may be able to comfortably fund your expenses from investment income (such as rental income from investment property or dividends from shares) and not need regular pension income.
Cons
No regular withdrawals
You can’t start a regular income stream from your accumulation account. However, it is possible to make lump sum withdrawals, if required, assuming you have met a condition of release.
15% tax rate
In the accumulation phase, all investment earnings are taxed at a flat 15% rate, whereas in retirement phase earnings and withdrawals (pension payments) are tax free.
Option 2: Commence an account-based pension
Pros
Tax-free status
One of the most important benefits of commencing a pension income stream is that any earnings on investments in your super pension account as well as pension withdrawals are tax free.
This is the most common reason people start an income stream if they have met a condition of release.
Flexibility of income
You can start making regular withdrawals to fund your lifestyle expenses. They can be made fortnightly, monthly, quarterly, or half-yearly.
You can also withdraw lump sum payments for any large expenses.
Cons
Minimum withdrawals
Once you start a super pension account, you must withdraw a minimum pension amount each year as mandated by the government. This is to ensure you use super for the sole purpose of providing retirement income and not as a tax-free vehicle for intergenerational wealth transfer. So, even if your expenses are less than the minimum pension rate, you are still required to withdraw that amount.
Capital depletion
To meet your regular income withdrawals, you may be forced to sell some of the investments supporting your super pension. Although some capital depletion is to be expected as you age, if you are withdrawing substantially more than your super is earning, your super may run out earlier than you planned.
Case study
We have made certain standard assumptions in our scenario below:
- Personal portfolio is invested aggressively in only Australian shares with a capital growth of 4% per year and income of 4% per year which is fully franked
- SMSF portfolio is invested in a diversified manner across growth and defensive assets with capital growth of 2% per year and income of 4% per year with only 25% franked income
- CPI is 2% per year
- All figures are in present value terms
- All surplus cashflow is invested into the personal portfolio.
Option 1: Leave super in the accumulation phase
In theory, this option seems financially advantageous.
This is because their personal portfolio gives them gross annual income of $120,000 with fully franked dividends. So they receive a tax refund in this case, as shown in the table below. As this is sufficient to fund their living expenses, they don’t see the need to commence an account based pension.
Also, if they commence an account-based pension, they will be required to take a 5% annual minimum pension which they will not be able to contribute back into super immediately. As their total super balances were equal to the transfer balance cap on 30 June, their non-concessional cap for 2023-24 is zero. They do not have the option to make personal deductible contributions as they are 67 or more and do not meet the work test.
They would therefore have to invest the minimum pension in their personal names, which would increase their personal assessable income.
If their individual total super balances fall below the transfer balance cap on a future 30 June, the option to make non-concessional contributions to accumulation the following financial year will re-open (until they turn 75). This could occur if investment return is not sufficient to compensate for withdrawals or when the transfer balance cap is indexed in future.
Option 2: Commence an account-based pension
John and Cassie both commence an account-based pension of $1.9 million each. Based on their age, they must take a minimum pension payment of 5% of their account balance which is $95,000 each ($190,000 combined). By doing this, they have transferred their entire $3.8 million SMSF into a tax-free environment.
Given they do not need this income, they invest in their personal portfolio outside super as they cannot presently make any more super contributions.
Based on our initial assumptions, let’s look at the net asset values and net cashflow over three financial years.
| Option 1: Leave in accumulation | |||
| Cashflow | |||
| 1-Jul-23 | 1-Jul-24 | 1-Jul-25 | |
| Pension Income | $0 | $0 | $0 |
| Personal dividend income | $120,000 | $125,254 | $130,908 |
| Tax refund | $11,352 | $13,238 | $13,076 |
| Living expenses | -$120,000 | -$122,400 | -$124,848 |
| Net cashflow | $11,352 | $16,092 | $19,136 |
| Tax on SMSF earnings (15%) | $18,490 | $19,412 | $20,382 |
| Net assets | |||
| 1-Jul-23 | 1-Jul-24 | 1-Jul-25 | |
| SMSF | $3,800,000 | $3,911,520 | $4,026,314 |
| Personal portfolio | $3,000,000 | $3,069,953 | $3,145,614 |
| Total net asset | $6,800,000 | $6,981,473 | $7,171,928 |
| Option 2: Commence an account-based pension | |||
| Cashflow | |||
| 1-Jul-23 | 1-Jul-24 | 1-Jul-25 | |
| Pension income | $190,000 | $191,380 | $192,780 |
| Personal dividend income | $120,000 | $132,854 | $146,686 |
| Tax refund | $11,352 | $11,122 | $10,530 |
| Living expenses | -$120,000 | -$122,400 | -$124,848 |
| Net cashflow | $201,352 | $212,956 | $225,148 |
| Tax on SMSF earnings (0%) | $0 | $0 | $0 |
| Net assets | |||
| 1-Jul-23 | 1-Jul-24 | 1-Jul-25 | |
| SMSF | $3,800,000 | $3,752,602 | $3,705,800 |
| Personal portfolio | $3,000,000 | $3,256,227 | $3,524,762 |
| Total net asset | $6,800,000 | $7,008,829 | $7,230,562 |
Based on the above calculations, John and Cassie are better off by $27,356 in 2024-25 and $58,634 in 2025–26 by commencing an account-based pension rather than leaving the SMSF in the accumulation phase.
They may also have the option to re-contribute non-concessional amounts to the accumulation phase later, depending on how their total super balances change and on the indexation of the transfer balance cap.
The decision between commencing an account-based pension or retaining super in accumulation phase and using investments outside super is highly dependent on individual circumstances. You should carefully consider your goals, tax implications, income needs, and desired level of control and protection over assets.
While an account-based pension offers tax advantages, it comes with minimum withdrawal rules and sequencing risk. On the other hand, retaining super in accumulation phase provides withdrawal flexibility since you are not forced to withdraw a minimum pension but involve higher tax rates than an account-based pension.
It is important for retirees to consider seeking independent professional advice from financial advisers or retirement specialists who can analyse your personal situation and provide comprehensive advice based on your specific needs. Making an informed decision will ultimately lead to a retirement strategy that aligns with your financial aspirations and ensure a comfortable and secure retirement.
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