Published: 30 Jun 2021
One big question Australians face when planning for retirement is whether to take their super as a lump sum or an income stream.
This isn’t a decision to be taken lightly; the choice of how to receive your superannuation funds will determine how comfortable you are in retirement. Statistics from the Association of Superannuation Funds of Australia estimate that a 65-year-old couple retiring in June 2017 needs an annual income of $60,063 for a ‘comfortable' lifestyle in retirement, assuming both are relatively healthy and own their property outright.
The good news is you can take the issue into your own hands by planning how you will receive your super. Start by weighing the pros and cons of a lump sum versus an income stream:
Choosing a Lump Sum
How it works
Depending on your fund, you may be able to withdraw some or all of your super in a single payment, known as a 'lump sum', or even several lump sums. This means you give up the option to receive future monthly benefit payments in exchange for a cash-out payment now.
What you then choose to do with your lump sum is important for your future. In Australia, only 16% of all super is taken in lump sum payments, with the majority of the money used to pay off home loans, renovate, buy a new property, invest, or clear other debts. Lump sums tend to be a more attractive option for people with relatively small super balances. Research by the Productivity Commission reveals that over 90% of people with up to $10,000 and around 30% of those with between $100,000 and $200,000 in super take their money as a lump sum.
Pros of a lump sum
- More flexibility
For many, the biggest drawcard of taking a lump sum is the freedom to choose how to use your super. You can invest it, make larger purchases (such as a car, travel or property), or pay off your mortgage or other outstanding debts. Ultimately, it’s your choice.
- Potential income streams
Depending on how you choose to invest your lump sum, you could still gain a regular income stream. For example, if you buy an investment property, you may get a regular income from renting the property.
Cons of a lump sum
- Tax implications
Super is tax-free after you turn 60, regardless of whether it’s paid as an income stream or a lump sum. (Though different rates may apply to untaxed funds, such as government super funds). But if you're under 60, you may have to pay tax on your lump sum withdrawal. Also, if you are withdrawing a lump sum before your preservation age, the lump sum will be taxed at 22% (including Medicare Levy) or your marginal tax rate, whichever is lower. ASIC provides more information on how this works.
Also, as soon as you take a lump sum out of your super, the money is no longer considered to be super. So, depending on where you then invest the money, there will likely be new tax implications on investment earnings, interest or capital gains.
- Future planning
There might be the temptation to spend the substantial amount of money sitting in your bank account, meaning you might risk running out of super earlier than if you took it as an income stream. It's important to remember that, when you take your super as a lump sum, you are responsible for making the funds last throughout your retirement. You may not be able to put the funds back into the super system down the track if you change your mind.
Choosing an income stream
How it works
Once you reach your preservation age, you can choose to receive a transition to retirement income stream. This means you will receive regular payments from your super, topping up your salary while you continue working. With an account-based income stream, the account increases and decreases as investment earnings come in, and fees and income go out. Alternatively, a non-account-based income stream guarantees a fixed level of income for life or a fixed term.
The Productivity Commission’s research shows that those with higher balances tend to move their super into income stream products, with account-based pensions being the most commonly used in Australia.
Pros of an income stream
- Improve your lifestyle
By topping up your regular income, you may choose to make changes to your lifestyle. This could give you the freedom and flexibility to reduce your working hours to part-time, take more holidays, reduce your debts faster, and more.
- Tax-free investment earnings
When your money is in a super fund, certain tax concessions can be beneficial when compared with investments outside of super. Remember that the tax concessions that apply to super are unmatched by other types of savings.
- Better budgeting
With an income stream, you have the flexibility to choose the amount you receive in pension payments each year and the frequency of payments to meet your financial needs (monthly, quarterly, half-yearly, or annually). However, the amount you receive is subject to a minimum percentage of your account balance, and a maximum percentage for transition to retirement pensions.
- Lump sum option
While you have the peace of mind that comes with receiving a regular income, you also still have the option to withdraw an extra lump sum if the need arises (and depending on your account balance).
Cons of an income stream
- Withdrawal rules
While typically there is no limit to how much you can withdraw as an account-based income, you have to withdraw a minimum amount each financial year. This is calculated as a percentage of your account balance and increases as you get older.
- Eligibility for Age Pension
Your entitlement to a full or part Age Pension depends on an income and assets test. So, an account-based income stream will impact your eligibility. The more income and assets you have, the less Age Pension you are entitled to receive.
- Lifetime cap on balances
On 1 July 2017 the Government introduced a cap on the amount of money that can be transferred to a tax-free account-based pension. The new limit is known as the 'transfer balance cap' and it has been set at $1.6 million. This is a lifetime cap and will be indexed in line with inflation, rounded down to the nearest $100,000.
- It won't last forever
Your income stream can only continue so long as there is money in your account – and there’s no guarantee how long your super income stream will last. It depends on how much you take out each year, what investment option you choose, market fluctuations and the fees you pay. Because your super account is exposed to investment markets, both positive and negative fluctuations will affect your account balance. So you need to think about what you’ll live on if or when your super runs out. The ASIC’s account-based pension calculator gives you an idea of how long your account-based pension will last.
The question of lump sum versus income stream has no right or wrong answer – the best choice depends on your circumstances. Before you make a decision, seek financial advice to help you assess all the factors and determine which option is best for your unique needs. Our Energy Super team is ready to help – talk to us today.