Retirement planning part 2 – The ins and outs of Account-based pensions
If you’re planning to retire and bid farewell to a regular pay cheque from work, you will likely need something to replace that cash flow. One popular option is to use your super to start an account-based pension. Let’s take a closer look.
What is an account-based pension?
An account-based pension gives you the option to use your accumulated super to pay yourself a regular income. To do this, you need to satisfy a couple of requirements. Firstly, you must have reached your ‘preservation age’; a technical term that refers to the minimum age at which you can get your hands on your super. The table below provides your preservation age based on your date of birth.
|DATE OF BIRTH
|Before 1 July 1960
|1 July 1960 – 30 June 1961
|1 July 1961 – 30 June 1962
|1 July 1962 – 30 June 1963
|1 July 1963 – 30 June 1964
|From 1 July 1964
You also need to meet a ‘condition of release’ to allow your super fund to release your money. Retiring after your preservation age is one such condition.
How much income can you receive?
Account-based pensions are quite flexible when it comes to setting your payment amounts, both in terms of the payment frequency and the amount you receive. Most providers let you choose whether to receive your payments monthly, quarterly, half-yearly or annually.
There is a minimum pension payment amount you will need to withdraw each financial year. This amount is expressed as a percentage of your account balance and varies according to your age as per below.
To work out your minimum pension payment for the year, you need to know your 30 June account balance and relevant percentage based on your age.
||MINIMUM % OF ACCOUNT BALANCE
|55 – 64
|65 – 74
|75 – 79
|80 – 84
|85 – 89
|90 – 94
|95 and over
Jean is 66 and had an account-based pension balance of $500,000 as of 30 June 2014.
Her minimum annual pension payment for the 2014/15 financial year will be $25,000 (i.e. $500,000 x 5%).
There is no limit on the amount of income you can draw each year (unless you have a transition to retirement pension). This means you are free to draw any amount above your minimum pension payment for the year. This may change in the future if the government decides to restrict the amount you can withdraw from your super.
How is your money invested?
It is up to you and your adviser to decide how your money is invested within an account-based pension. You will need to work out how much risk you are comfortable with and select the investment options that best fit your risk tolerance.
Most super funds provide a range of investments options, including cash, shares and property. The investments menu can vary considerably between different providers, so it’s best to check with your fund for a definitive list.
Are investment returns guaranteed?
No. The investment returns you receive on your money depend on how you invest it.
There is also no guarantee on how long your money will last. Factors such as how much you withdraw each year and the investment returns generated will largely decide this outcome.
How is an account-based pension treated for tax purposes?
Once you reach age 60, your pension payments and any lump sum withdrawals will be generally tax-free. Prior to reaching the big 6-0, some tax may be payable depending on a range of factors.
The earnings from investments within your account-based pension are tax-free. This applies to any income paid such as bank interest and dividends, along with capital gains that you realise by selling investments for a profit.
These tax-free earnings remain in your account and increase the account balance over time.
All in all, this makes for a very tax effective structure!
How does Centrelink assess an account-based pension?
When it comes to assessing income from your financial investments, the Government assumes that you will be earning a certain rate of return, regardless of the actual interest rate you receive. This system is known as deeming.
Deeming applies to most financial investments with a few notable exceptions, including real estate and business assets.
Account-based pensions are now categorised as ‘financial investments,’ which means these deeming rules will apply.
If you were an age pensioner and owned an account-based pension prior to 1 January 2015, special rules apply. For more information, please see Deeming Changes 2015 – Centrelink Treatment of Account Based Pensions.
Other things to keep in mind
Placing your retirement nest egg into an account-based pension should not be a set-and-forget strategy. Payments are not guaranteed to last your lifetime, as they are often linked to market performance and the ups and downs of the share market. A dip in the market could mean your pension payments decrease from one year to the next. It is important to review your situation and make adjustments where required.
Wally David, CFP®
Financial Planning Matters