Is your instinct when reading about pensions or income streams to run for the hills or stifle a huge yawn? Would you become more interested if knowing about them could give you thousands of dollars in extra income each year? Then read on.
There are basically two broad choices when you stop working and move from accumulating money in your superannuation fund to living off the proceeds: start what’s called an account-based pension or cash the money out and invest it yourself.
If you’re over 60, anything you remove from super is tax-free.
The big benefit of an account-based pension is also related to tax – there is none on earnings and capital gains (compare this with paying the marginal rate if you invest the lump sum in your own name).
And a couple of benefits
There is, however, another advantage that’s less obvious but huge: assets held in this sort of pension are assessed more favourably under the government income test than money in your own name. That can mean more likelihood of getting the age pension down the track, as well as much cheaper fees if you ever need to go into aged care.
Now that is likely to be far from the immediate horizons of impending retirees, who are probably more focused on what to do with their new-found freedom than their failing health at some point in the future.
But, says financial planner Suzanne Haddan, managing director of BFG Financial Services, it’s important to remember the link between the rules for aged care. “Account-based pensions are advantageous for the income test for Centrelink [for the age pension] as well as the income test for aged care,” she says. “It can add up to serious dollars in terms of reducing fees.”
She cites a client who recently faced a premature and unplanned move to assisted living (suffering with dementia at 71 years old) and whose annual fees are almost $9000 a year lower than if her assets were in her own name.
It’s all about planning ahead, which makes it clear that while many people looking to end their working days focus just on what they’re going to do with their super money, there is a much broader picture to be considered.
“There’s no quick answer,” Haddan adds. “It involves sitting down with a client to work out if they are going to be eligible for Centrelink, fine-tuning that; deciding how much can be kept in a pension and how much to take out; whether they have a sick partner and whether aged-care fees are likely to come up in the future … all these will tilt my advice.”
In or out
There is an argument that, depending on your assets, your tax situation could be the same whether inside or outside the super system. Taking into account the senior Australians offset (applying to retirees over 65) members of a couple can earn $26,680 each and singles $30,685 and pay no tax (as at March 2012).
“[But] don’t rush to withdraw your money from an account-based pension just because the outcome is neutral,” Haddan cautions. “You don’t know whether you’ll need it in a pension because of aged care or Centrelink. You can’t put your money back into super easily after the age of 65.”
The mechanics in starting an account-based pension are relatively simple, advisers say. Most corporate and industry funds can move you across to their offerings, says Assyat David, director of industry adviser Strategy Steps.
For those with self-managed super funds, a letter needs to be written to the trustee outlining your wish to move to a pension, says Graeme Colley of the SMSF Professionals Association of Australia.
The fund would need to ascertain your share of the assets and which parts are taxable. And like the non-DIY pension, you’d need to work out how often to receive payments and how much they should be. You’d also have to stay within official government limits, which range from 3 to 10.5 per cent of the value of the fund, depending on your age.
“Setting up the pension is the easy part,” financial adviser Andrew Carra adds. “Working out how to optimise Centrelink; estate planning and cash flow management; managing fears during periods of volatility; and dealing with changing laws is the hard part.”
As Colley points out, if you’re under 65 and your minimum drawdown is 3 per cent, it’s OK for the fund to be making only 4 per cent. But above age 80, while taking at least 5.25 per cent, it won’t be. As you get older, “chunky” growth assets will need to make way for income-producing holdings, such as fixed interest and cash.
Managing cash flow is crucial. Assyat David suggests a “bucket” approach, in which three to five years of income is in cash, while the bulk of the rest goes into growth assets that can fluctuate with the market – and hopefully help your portfolio grow.
The current global economy is a reminder that downturns can last a lot longer than five years. Insurance products such as annuities, while they have been out of favour due to relatively low returns, can be built into a portfolio to provide some certainty.
Case study: How much to withdraw
Charles andLisa own their home and have $300,000 in super, from which they want to draw $25,000 a year. If this is taken as part of an allocated pension, adviser Andrew Carra says, their age pension will be $13,995 each. So their total income for the year will be $52,990.
But say instead they take out the $300,000 as a lump sum from super and invest it in their own name. If they withdraw the same $25,000 from these savings, it is assessed differently under the Centrelink income test and they will receive a lower age pension of $13,297 each. Their total income will be $51,594, which is $1396 less than if they’d taken the income from an allocated pension instead of holding the money in their own name.
Admittedly, this is a large annual withdrawal for such an amount of super, as it means they will eventually run out of money. But this example shows what a difference the way you take your income stream can make. Carra says this couple could scale back after a few years, or downsize, to free up funds.