The superannuation system is designed to build wealth in order to provide us with income in our retirement years.
Once we retire and need income, the most efficient way to do this is by converting our superannuation to pension phase and commence an income stream.
Once in pension phase, all earnings are tax-free as is the income you receive. There are two types of income streams; account-based pensions and annuities. Each has competing strengths and weaknesses and they work really well together by having a combination of both.
An account-based pension, also known as an allocated pension, is by far the most common income stream. Account-based pensions are offered by most superannuation providers and there is a wide array and choice of funds.
The main strength of the account-based pension is flexibility. You are able to choose how you invest your funds (as you do with your superannuation). You can also select the level of income you require and are able to make withdrawals as you please.
The value of the account-based pension goes up and down in line with investment returns and withdrawals.
Once you run out of money, the pension stops. In the event of your death, the remaining value of your account-based pension is passed on to your estate.
The full value of the account-based pension is assessed for Centrelink asset test purposes. It is also subject to deeming for the income test, in the same way as other investment assets. Older account-based pensions may be entitled to more favourable treatment for the income test.
With account-based pensions, you bear investment risk and longevity risk.
Annuities pay you a set income for a set period of time. You are able to nominate a time frame and a portion of your investment you would like back at the end of the period. The annuity company will pay you a pre-determined pension for the designated time frame.
You are also able to select a lifetime pension, in which you receive an income for the rest of your life.
The newer lifetime annuities offer guaranteed payment terms, periods you can access your funds and other options that weren’t available in earlier life time annuities.
This makes them a little more flexible than they once were.
Annuities are very secure in that they offer guaranteed payments with the annuity company bearing the investment risk.
Lifelong annuities and annuities with benefit periods of longer than five years with no return of capital, have favourable Centrelink treatment. In the case of lifelong annuities, they also bear the longevity risk.
The weakness of annuities is that they typically have lower investment returns and are very inflexible.
Taking lump sums is not possible and the income received is set in advance.
Always seek advice.
Alex McKenzie, Future Financial Services
Alex McKenzie is a financial planner, and the owner of Future Final Services in Penrith. He is a graduate of Western Sydney University.