In this guide
With a bit of luck, during your working life you will accumulate a tidy sum in super. When the time to retire arrives, those savings will help support you through your non-working years.
While you’ve had a long time to practice saving, converting those savings into retirement income is something you may only do once and it can be daunting. SuperGuide has put together this explainer to help you understand your options.
Note that if you are a member of a defined benefit fund your options at retirement may be different.
What are my options?
For super purposes, retirement means meeting a retirement condition of release. Once you do, there are no ‘cashing restrictions’ which means you can access any amount of your super in any way you choose.
The relevant conditions of release are retirement and reaching age 65. You can get your hands on all your super:
- When you turn 65 – including if you’re still working or have never worked
- When you’re at least 60 and have permanently retired from work, or
- When you leave a job after your 60th birthday – including if you’re returning to work.
Once you meet a retirement condition of release, there are four options available to you for your accumulated super balance. You can:
- Convert your super into a pension (also called a retirement income stream)
- Cash a lump sum
- Leave super in the accumulation phase (such as in your current super account)
- Combine two or all three above options.
Pensions
A super pension provides you with a regular income to live on in retirement to help replace the income you previously received from work. The most common type in the Australian market is an account-based pension, but there are also lifetime and fixed-term pension options. The maximum amount you may transfer into pension accounts for retirement is currently $1.9 million per person – this is called the transfer balance cap.
When the goal is generating retirement income, it’s hard to go past a pension product. Investment earnings are tax free (except in the case of transition-to-retirement pensions) and a pension account can provide sustainable retirement income by continuing to invest your savings while making regular payments to you.
Account-based pensions (non-lifetime)
When you put money into an account-based pension, you choose how the balance should be invested. That balance then earns tax-free investment returns and your regular income payments are deducted from it. When you are aged 60 or more, these regular income payments are also tax free. There is a mandated minimum percentage of your balance you must draw as income each year that increases as you age, and you can withdraw lump sums whenever you wish.
Features of account-based pensions:
Flexibility
Choose the income amount that suits you and change it as needed, withdraw lump sums if required and choose how your funds should be invested. Roll over your balance to another super fund at any time. You can even transfer some or all of your pension account back into an accumulation account if you no longer want to draw income from it.
Tax-free status
Tax-free investment earnings mean your account can grow more quickly than a comparable investment outside super because tax is not eroding your returns. Your regular income withdrawals are also tax free if you are aged 60 or more, unless you are a member of an untaxed fund (these are uncommon).
Estate planning
Any balance remaining in your account after your death is passed on to your beneficiaries. You may choose for your spouse to take over ownership and continue receiving the pension (reversionary pension) or a lump sum may be paid.
Longevity risk
There is no guarantee that your balance will last for life. Investment losses or lower returns than you planned for could mean your balance is depleted earlier than you expected. The sequence of investment returns is also important.
Centrelink assessment
The balance of your account is counted in the assets test and deemed income is calculated for the income test to determine your Age Pension eligibility and/or eligibility for other Centrelink benefits. The actual level of income you withdraw is not assessed, only the deemed amount. Note that pensions opened prior to 1 January 2015 may be assessed differently.
Most super funds offer an account-based pension.
Fixed term and lifetime pensions and annuities
Fixed term and lifetime pensions are usually non-account-based. In a non-account-based pension you do not have an individual account balance, but rather purchase an income on agreed terms with a product provider (a super fund or a life company). When a non-account-based pension is provided by a life company it is called an annuity. Annuities can be purchased with super or non-super money, but pensions provided by super funds can only be purchased with money that has first been contributed to super.
If you are a member of a defined benefit super fund, the fund may be designed to pay you a lifetime pension rather than having an account balance.
Innovation in retirement products has also led to the development of the option to create a lifetime income stream while maintaining an account that holds your personal balance – an account-based lifetime pension. In this case, maximum withdrawal limits apply to ensure your balance can’t run out and insurance also may be used to top up your account.
Features of lifetime and fixed term pensions/annuities:
Longevity protection
Income will be paid for life or for the fixed term agreed. It cannot run out. You may also use a deferred annuity which doesn’t start paying income until you reach a set age – a good way for income to ‘kick in’ when you expect to have depleted your other retirement savings, including any account-based pension.
Favourable means testing
Under Centrelink’s means test rules you may receive a higher Age Pension by investing in a lifetime product. When the product you choose meets the rules for favourable treatment (known as the social security capital access schedule), only 60% of the purchase price is counted in the assets test. When you turn 84, or after you have held the product for a minimum of five years, whichever occurs last, this reduces to 30% of your purchase price. For the income test, 60% of the income you receive is counted. During a deferral period when you are not receiving income, no income is assessed by Centrelink.
Investment risk
In a traditional product, you don’t bear the risk associated with fluctuations in investment markets. The provider pays you the agreed regular income regardless of how their underlying investments perform, and you can choose to have your income indexed to keep pace with inflation.
Modern products offer the option to instead have your income varied in line with the return of your chosen investments. This means you may be exposed to the risk your income can go down from one year to the next, but you can often receive higher income on average. Some products also provide protection from negative market movements, preventing your income from decreasing.
In an account-based lifetime pension your account balance fluctuates in line with your withdrawals and returns from your chosen investments.
Estate planning
The product may continue to pay income to your spouse after your death and you may be able to choose an option that would pay a lump sum to an alternative beneficiary.
In the past, many people were reluctant to choose lifetime products because if they died before they had received the entire amount they invested back through income payments there was often no further benefit payable. Most modern products do not present this problem. The provider often guarantees that you will receive at least your initial investment amount through the combination of income paid during your life and death benefits after you pass away.
However, if the product complies with the capital access schedule for favourable Centrelink means testing, the maximum lump sum death benefit is 100% of the purchase price until you’re halfway between the purchase date and your life expectancy. Afterwards, the maximum declines steadily from 50% of the purchase price to zero when you reach your life expectancy. These limits mean it is possible you will not receive the full value of your initial investment.
Flexibility and complexity
These products are less flexible and more complex than non-lifetime account-based pensions. The level of income is set by the provider and usually increases only with the agreed method of indexation. Alternatively, you may be able to choose from a range of income options within minimum and maximum limits.
The option to make a partial withdrawal of a lump sum and continue receiving a smaller lifetime income afterwards is only rarely available but it is usually possible to close the product entirely and withdraw its remaining value until you reach your life expectancy.
It is usually not possible to transfer any remaining value or balance to another product after you have invested.
Product features vary widely, and more new products will continue to be developed. Understanding all the features and costs of the available options can be difficult.
A popular strategy is to combine an account-based pension with a lifetime pension, to get the best of both worlds. TelstraSuper provides a calculator that can model how one such combination could work for you.
Lump sum
You may withdraw a lump sum from super at retirement of any amount up to your total balance. A lump sum payment can be useful if you need to repay debts, or you have some large expenses such as making home renovations or purchasing a vehicle. Lump sum withdrawals from taxed funds are tax free for people aged 60 or more.
Why take a lump sum?
Apart from debts and expenses, there are some strategic reasons a person may take a lump sum from super.
- Gifting the amount withdrawn to another person may improve eventual Age Pension entitlements.
- The lump sum withdrawn could be contributed back to super. This is called a recontribution strategy.
Downsides of taking a lump sum to invest outside super
If you invest money you have withdrawn outside the super system, any returns on your investment will be taxed as normal income at your marginal rate, not at concessional super rates (a maximum rate of 15% in an accumulation account and tax free in an income stream). For many people, this means more tax on earnings, and therefore less money credited to your investment, if money is invested outside super.
Accumulation phase
In the super system, there are two phases. The accumulation phase, where your savings accumulate while you are working, and retirement phase, where a pension has commenced and a regular income is being paid.
If you don’t want to use all your super to start a pension or take a lump sum, money can be retained in the accumulation phase throughout retirement. Earnings on any amount retained in accumulation will continue to be taxed at the concessional rate of up to 15%.
Why retain money in accumulation?
- If your total super balance exceeds the transfer balance cap (currently $1.9 million), it is not possible to transfer the amount above the cap to a pension. Leaving the excess in the accumulation phase means its earnings are taxed at a maximum of 15% instead of being exposed to income tax rates outside super which could be higher, particularly if you are still working or have income from other investments.
- For people under the Age Pension age, funds in accumulation accounts are not assessed in Centrelink means tests. Retaining money in the accumulation phase can improve Centrelink entitlements such as the Age Pension of your spouse if they are older than you, or your own entitlement to a payment like Disability Support Pension. When you reach Age Pension age, funds in the accumulation phase are assessed in means testing.
- Annual payments must usually be drawn from super that has been transferred into the retirement (pension) phase. If you don’t want to be forced to withdraw income, and thereby remove money from the tax-advantaged super system, you may choose to retain money in an accumulation account. Note that anyone up to the age of 75 is now able to make super contributions, so while you’re under 75 any income withdrawals from a super pension you do not spend can be contributed back into an accumulation account if you wish – subject to contribution caps. There is also the option to invest in a deferred annuity if you would like to invest in an income product that does not require withdrawals to start immediately.
Combining options
For many people, the most desirable retirement outcome is a mix of options.
Perhaps you need a small lump sum to clear the mortgage and want to convert the rest of your account to a pension to provide retirement income.
If you’re lucky enough to have accumulated more than the transfer balance cap, you might transfer the maximum to a pension, leave some in an accumulation account and cash a lump sum to take that once in a lifetime holiday.
Maybe your spouse is still working, and you don’t need income from your super yet. You might keep a small balance in accumulation, transfer the rest to a pension account for the tax-free earnings and reinvest your compulsory income payments back into your accumulation account as super contributions where they can continue to grow.
The bottom line
You should now have a good grounding in the possibilities for your super post-retirement. Income stream products (particularly lifetime options) can be complex, so make sure you carefully read the Product Disclosure Statement (PDS) and ask all your questions before investing. To make the most of your retirement savings, a professional financial adviser can assess your overall situation and recommend the most suitable strategies for you.
