Account-based pensions are the most popular type of retirement income stream for retirees. They offer both flexibility and ease of understanding and can be purchased from a professional fund manager or run within a self-managed superannuation fund.
What are account-based pensions?
An account-based pension is basically an income stream that is payable from a superannuation fund.
Anyone with accessible superannuation money – that is, “unrestricted non-preserved” superannuation money – can either rollover to, or directly purchase, an account-based pension. You don’t necessarily need to be retired to start the pension but you do need to have met a condition of release so that your money becomes accessible. In some cases, you can open an account-based pension even before your superannuation money becomes unrestricted non-preserved (under transition to retirement rules) but you should seek help from a financial planner to determine if this is appropriate for you.
You can purchase an “off the shelf” account-based pension from a fund manager, or alternatively you can commence one within your own self-managed superannuation fund.
How do account-based pensions work?
Account-based pensions operate similarly to a regular bank account in that investment earnings top up the account balance, and withdrawals in the form of regular pension payments reduce the balance.
Pension payments within a financial year must be at least equal to the legislated minimum amount (based on age). There is no maximum on a standard account-based pension so you can choose how much you want to receive. You can elect to receive payments at regular intervals, for example, monthly, quarterly, half-yearly or annually.
In addition to regular pension payments, lump sum withdrawals – known as ‘commutations’ – may be made from account-based pensions unless the transition to retirement rules apply.
Account-based pensions can be invested in a broad range of investment options that can be selected to suit your needs. They allow investment in the major assets classes such as cash, bonds, shares and property in addition to alternative assets classes, if desired and depending on the offer by your selected provider.
Why are account-based pensions so popular?
The popularity of account-based pensions is due to tax concessions but also due to their flexibility and versatility. Account-based pensions allow flexibility in relation to income, access to capital, investment options and payment possibilities in the event of your death.
Each year you need to take a minimum pension payment from your pension but you have a great deal of flexibility to increase the pension payment anywhere up to 100% of the account balance. How much you take will impact how long your pension lasts. If you need additional money in a particular year you can take out extra by increasing income or taking a lump sum commutation.
If you are age 60 or over and the pension is paid from a ‘taxed’ source, pension payments and commutations will also be received tax-free. If you are under age 60, tax may apply to pension payments and commutations, although a portion may be tax free and/or entitled to a 15% tax offset.
Investment earnings on the underlying assets of an account-based pension are added to your account entirely tax-free but you are only able to roll over a total of up to $1.6 million of superannuation savings to start retirement income streams. If you have higher savings in superannuation, the balance will need to remain in accumulation phase (with 15% tax) or be taken out of superannuation.
It is also important to note that the tax-free status of earnings will not apply to any pensions paid under the transition to retirement (TTR) rules. The earnings in a TTR pension will be taxed at 15%.
In the event of your death, the account balance may be paid to your beneficiaries or estate as a lump sum. Some beneficiaries may be eligible to select to continue the benefit as a pension. This is a complex area and advice can help determine the best option.
Your situation can be examined to determine the taxation implication of account-based pensions.
What about the disadvantages?
Probably the biggest disadvantage of an account-based pension is the risk that your savings will not last your lifetime and your income will stop. This will largely be determined by your starting balance, the investment performance of the underlying assets and how much you choose to take out each year.
There is also a limit on how much money you can have in account-based income streams.
Illustration of an account-based pension
Consider an account-based pension purchased by a 65-year-old for $300,000. Suppose the assets earn 7% per annum and the annual pension is elected to be $20,000 in the first year, indexed at 3% each year thereafter.
The following graph indicates how much pension would be paid each year as well as how the account balance changes over time.
Is an account-based pension for you?
For most retirees, account-based pensions will play a significant role in generating retirement income.
The attractions are undoubtedly the flexibility and the tax-free environment from age 60. It makes sense to consider investing part of your retirement savings in an account-based pension to provide flexibility to meet your changing needs but with advice to ensure your individual needs are met most effectively.
Get in touch if you want any more information about account-based pensions – we can explain whether an account-based pension is appropriate for you. Have some questions? Want to know how it applies to you? Want a review of your personal situation? Click here to book a Free 15 Minute Discovery Session, give us a call on 1800 577 336, or email us at hello@wealtheon.com.au.
Information on this site may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.