How superannuation converts into retirement income

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The Superannuation Guarantee that came into effect in 1992 means that most Australians have a sum of money to finance at least part of their retirement.

When it comes to spending your retirement savings, it’s about working out how to use that money to deliver the best possible retirement based on your circumstances. For an increasing number of older Australians, that will involve a lifetime income stream, which will provide a guaranteed and regular payment for life.

The importance we attach to encouraging people to save money throughout their working life can mean that when they actually get to retirement, they’re not that keen on spending it. That is, they’re not that comfortable consuming their capital when the time comes to drawing down.

A lifetime income stream can help smooth spending of retirement income and boost retirees’ confidence.

Some nations have made annuitising their defined contribution savings compulsory. In contrast, Australians have the freedom (in theory) to pull everything out once they reach retirement.

That’s what retirees can do in theory, but very few actually do that because once they have built up a decent nest egg, few people aspire to live just on the Age Pension.

When balances were relatively modest – say you had $40,000 in super – you might have said, ‘Well, I’ll buy a caravan and go around Australia.’ But we estimate the average household now retires with about $400,000. People now tend to think, ‘Well that’s quite a decent amount of money. If I use it wisely, it will give me a better retirement.’

In other words, the light is turning on and we’re reaching the right sort of conclusions about what we’re supposed to do with our super.

So what is the smartest way to spend your retirement savings? The Fitzgerald report in 1993, shortly after super started, suggested the retirement phase would be typified by retirees drawing down regular pension payments from their savings. This is not happening as frequently as was projected.

The idea was that you have the saving phase with relatively simple accumulation and you would get to a more annuitised retirement, that is, a guaranteed income for life. But that hasn’t come to fruition yet.

Basically, you can have an account-based pension, which is what 95 per cent of today’s retirees do. The Government requires you to start off by drawing out five per cent, then it goes up to six, seven, eight, nine and even all the way up to 14 per cent when you’re in your 90s.

But the account-based pension can run out if you overspend, or you could underspend and end up with a lower standard of living in retirement than is really necessary. Your adult children might benefit through an inheritance, but you don’t get the opportunity to enjoy the retirement you deserve.

The other option is to invest part of your retirement savings in a lifetime income stream product such as an annuity, and ensure you have income for life.

So how can you achieve a balance?

The main difficulty is that nobody knows how long they’re going to live. Even average life expectancies, when you examine them, can be quite confusing, which makes knowing how long your money needs to last even more tricky. Health, family history and a multitude of other factors make it even more difficult for you to predict your own longevity.

Again, that’s where annuities come into play. Like the Age Pension, a lifetime annuity provides regular and guaranteed payments for life. An annuity that is indexed for inflation will help you to continue to afford tomorrow what you can afford today.

You can buy a term deposit at a fixed rate, but unlike bank term deposits that have a time horizon of one, three or five years, when you purchase a lifetime annuity, it comes with a guarantee that you’ll be paid for the rest of your life.

It’s important that older Australians understand lifetime income streams such as annuities in order to invest in them with confidence.

That begins with knowing the detail of how they fit in to your retirement portfolio – the advantages, that they’re not really that complex and the way recent government changes have made them more attractive.

On 1 July, Centrelink’s means test rules changed. Only 60 per cent of an investment in a lifetime income stream that meets new capital access rules now counts as an asset up to age 84. And just 30 per cent of the amount invested will count as an asset after the age of 84.

This means that if you invest $100,000 into a lifetime annuity, for the Centrelink assets test it will be treated as an asset worth $60,000 and your Age Pension will be adjusted accordingly.

As a result, if you are on a part Age Pension, you may be eligible for an increase to your pension entitlement.

A significant reason the Government changed the means test rule was to encourage the development of lifetime income streams to improve long-term financial security for Australian retirees. The Government is continuing to progress further reforms that will encourage the take-up of these lifetime income streams.

As with most aspects of life stage planning, knowledge is power, so the provision of clear explanations on the way lifetime income streams can reduce money concerns is vital. As a first step, download your free copy of Challenger’s A guide to a confident retirement

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