The art of cashing in at retirement

There were lots of Australians in the past who relied solely on the Age Pension. There will be lots of Australians in the future who rely exclusively on their super funds. Between those two groups of people, there will be those who need to think hard about how they balance different types of retirement income to support the lifestyle they've become accustomed to. This article is for them.

By Nigel Bowen

Retirement is a financial stage of life undergoing rapid reinvention.

Compulsory superannuation, increased age eligibility for the Age Pension and rising desire to balance meaningful work with lifestyle goals like travel, volunteering or caring for others mean most of us need a better understanding of superannuation - as well as our own investing, lifestyle and spending habits - to make decisions about how we access cash and income as we get older.

Money in, money out

There are 2 non-negotiable phases of the superannuation process and one optional one. You direct money into your super fund while earning an income and take it when you retire.

Given many people reduce their hours (and income) as they approach retirement, it is also possible to start withdrawing money from your super account after reaching what’s called “preservation age” (60 for anyone born after mid-1964) but before reaching the official retirement age (67).

Once you reach preservation age, you can organise a Transition to Retirement (TTR) pension. This is an account-based pension (see below). Because TTR pension payments are lightly taxed or untaxed, they can be attractive to middle-income and high-income earners who want to reduce their workload and tax bill during the final stage of their career.

The art of cashing out cleverly

Once you’ve fully retired and hit the deaccumulation, aka retirement, phase, you have 3 options: withdrawing your super money as a lump sum; setting up an account-based pension; or buying an annuity.

(1)  The lump sum option

The upside of a lump sum is having money to pay off debt or buy goods and services. The downside is that you’re reducing, often significantly, your capital. The value of your primary residence doesn’t affect your eligibility for the age pension, while the value of your other assets, including your super, does. So, it may be worth considering using some of your super to eliminate your mortgage. One or more lump sum withdrawals may also reduce the tax you pay and maximise your age pension. Plus, if you use the lump sum to invest in an asset, that asset may provide a return. After 60, lump sum withdrawals are usually tax free.

(2)  The account-based pension option

Imagine you have $400,000 in your super account and would like to withdraw $40,000 a year until your funds are exhausted. In this case, you can opt for an account-based pension, aka an allocated pension. Your super money stays invested and (ideally) keeps earning a return, and your super fund keeps paying out until your money is gone.

You can set up an account-based pension plan when you reach preservation age and pension payments are tax-free from 60. However, your eligibility for the age pension may be affected given that account-based pensions are included in the income and asset test. There’s also the risk an economic downturn could reduce the total amount of income you were expecting to receive. 

(3)  The annuity option

If having an account-based pension is like investing in the share market, purchasing an annuity is the equivalent of buying bonds. If someone with $400,000 in an account-based pension is paid $40,000 a year, their super money will last indefinitely so long as it earns at least a 10% return. Alternatively, a 0% return means the super account will be empty in 10 years. (Or less, once fees are taken into account.)

Let’s say you purchase an annuity for $400,000 that will pay you $40,000 for 15 years once you turn 67. You will receive the agreed income for the agreed period but will be locked into the arrangement. For instance, you can’t decide you want $120,000 this year and $0 for the following two years.  

Annuities provided modest returns during the post-GFC, pre-pandemic ‘zero interest rate’ era. But they have become a more attractive investment option as rates have risen. As the AFR recently reported, the return on a 10-year annuity used to be 2.35% but is now 5.35%. This has increased demand for annuities among retirees and soon-to-be retirees keen on low-risk, solid-return investments.

You can mix and match

It’s possible, indeed common, to combine retirement income streams. Someone who retires with $400,000 in their super account might withdraw $100,000 to pay off their mortgage, purchase an annuity for $150,000, and then put the remaining $150,000 in an account-based pension. In such a scenario, our hypothetical retiree will have minimal housing costs. They’ll also have the reassurance of a set amount of money coming in from their annuity and the capacity to ramp up payments from their account-based pension if they, for instance, incur a sizeable medical bill.      

Hoarding is discouraged

Many Australians worry about running out of money in retirement. However, people passing on without having much of a dent in their super balance is such an issue that the government has had to legislate to ensure retirees draw down their money.

To summarise, once you hit 65 you must withdraw at least 5% of your super balance every year. That rate increases as you age, topping out at 14% for those 95 and older. So, if you were a retiree with a $400,000 balance, you’d need to withdraw $20,000 - $56,000 a year, depending on your vintage.

You can draw down more, but you can’t draw down any less.   

Relax – the Age Pension is still there as a backup

People sometimes worry that they will end up disadvantaged by the switch from an Age Pension-based system to a superannuation-based one. Such fears are understandable but usually ill-founded.

Taking a lump sum, or setting up an account-based pension, or purchasing an annuity can impact your eligibility for the Age Pension and possibly the amount of tax you pay. This is one good reason to do your homework before deciding how to allocate your super money. (Plenty of free information is available from your super fund, the ATO, MoneySmart and the Financial Information Service, and you may also wish to consult with a financial adviser.)   Read more about how to calculate what you need for retirement on Citro. 

But there’s rarely a reason to be concerned about running out of money in retirement. If your income falls below a certain level, you will almost always qualify for a part or full Age Pension.    

_{Advice given in this article is general in nature and does not take into account your personal circumstances. It is not intended to influence readers' decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.}