We all get used to the concept of planning our spending and saving around “payday”. Whether we’re old enough to remember an envelope of paper notes and a pay slip, or whether we’ve only ever been paid in pixels, payday is a big day.
It’s the same when we retire. Even if you have significant savings, having a regular, reliable income stream during retirement can have a significant impact on both your financial wellbeing and your peace of mind.
Until quite recently, most Australians took a “lump sum” into retirement, and were responsible for how that was invested, but it has become much more common to convert superannuation benefits into a retirement income stream. This allows you to set up a flexible income stream to suit your lifestyle in retirement. Because it retains a similar feeling to being paid, the retirement income stream has struck a chord with retirees.
“People do seem to like having that regular income,” says Peter Rambert, a Financial Adviser. “It’s comforting, and it helps retirees with their budgeting.”
There are two main types of income streams, says Peter: allocated pension accounts and annuities.
Account-based income streams – commonly referred to as “allocated pensions” – are by far the most popular with retirees, says Peter. Why? They provide a great level of flexibility.
“You can vary the amount of income you receive, and the frequency and timing of each payment, depending on your changing requirements. However, a specified minimum payment must be taken each year,” he explains.
Unlike the interest you receive on money in the bank or from returns you make on investments outside super, income from an account-based pension – and the investment earnings on your account – is usually tax-free when over age 60.
An account-based pension also allows you to withdraw a lump sum at any time from the funds underpinning the pension. “If you want to take out $30,000 to travel or to buy a car, you can do that in an allocated pension,” says Peter.
In addition, you have the flexibility to select the account’s underlying investments. “Your portfolio can lean towards growth assets or defensive assets and this will depend on the investors risk profile, comfort levels around risk and volatility and life expectancy factors,” says Peter. “Any changes to the asset allocation should always be discussed with your licenced financial adviser.”
This feature is important, because it allows people who have a greater ability to tolerate risk and potential volatility to allocate extra funds to growth assets, giving their savings a chance to continue to grow.
The account-based income streams are also a great option in estate-planning terms. “You can transfer any residual capital to an estate, and nominate a preferred or dependent beneficiary – they can receive a reversionary payment, or pension, upon your death,” says Peter. “You have a lot of flexibility right across the board.”
Non-account-based pensions are more commonly called “annuities”. With this product, you use your retirement benefit funds to purchase a non-account-based pension from a provider; in return, you receive a guaranteed, regular payment.
“The term and the return of an annuity is set at the outset, and this term can either be fixed – varying from one or two years – through to lifetime,” says Peter.
“Annuities are less flexible than account-based pensions, because you can’t adjust the amounts, and you generally can’t withdraw a lump sum. It’s these features that make them well suited to people who are highly risk-averse. They can sleep soundly at night knowing that they will get a certain amount of income each year, and the payments are guaranteed.”
Although they are the less flexible option, annuities still allow you to nominate a dependent beneficiary who will receive a reversionary pension if you die and in some instances, a lump sum might be available.
Allocated pensions do not require a large retirement benefit: even a modest super balance can be used to create a retirement income stream as a tax-effective way of augmenting the Age Pension and providing a better standard of living. The Age Pension will still play an integral part of the retirement-funding picture for many people.
Assets outside superannuation can also be used in conjunction with superannuation assets in order to meet your cost-of-living objectives. “Some annuity products, for example, may be purchased with non-superannuation moneys, and contribute to retirement income,” says Peter.
As well, both account-based and non-account-based pensions can be used in conjunction with other assets. For example, many retirees have Australian share portfolios and derive dividend income from these, with the added advantage of the annual tax rebate from franking credits and the tax-free threshold, which currently sits at $18,200 per year.
“The key is to have a tax-effective retirement income stream. Shares can be part of that,” says Peter.
Whether you decide on a fixed income or choose a more flexible approach, having a regular “payday” in retirement can give you a sense of security – which is vital for your wellbeing – and allows you to better manage your day-to-day budget.