Why a large super balance can actually reduce your retirement income
Idea
People with low to medium super balances often feel left out when it comes to retirement. They look at people with $1 million or more in retirement and assume that those people are enjoying the ‘epic’ version of retirement while others are just passing by.
But that’s not how the Australian superannuation system actually works.
One of the quirks of the system is that there is a sweet spot where pension and age pension combine very efficiently. In some cases, a person with moderate savings can earn almost the same income, or even more, than a person with much higher savings, simply because they are entitled to a much more significant slice of the pension.
This sweet spot has changed again due to the increase in the old-age pension from 20 March. And we see not only the standard indexation of ceilings, but also our second rise to the considered rate in a year.
This changes where pension and superannuation are combined, giving someone with less income more income at the same deduction rate than pension and superannuation combined.
The point to understand is that the sweet spot is not a fixed number for every retiree. It depends on how your assets are structured. There are two basic limits to the old-age pension. There are thresholds at which you qualify for the full pension and then higher levels where the pension ceases entirely.
Retirement income in Australia is tiered. The amount you have in Super is important. The amount you are entitled to from the old age pension is the same.
For example, as of March 20, a single homeowner could receive the full-age pension with assets up to approximately $321,500, while a homeowner couple could have assets up to approximately $481,500. Above these levels the pension does not stop, it gradually decreases as your assets increase.
This is called contraction. For every $1,000 above the assets test threshold, your pension is reduced by $3 every fortnight. This taper is where the magic happens. This is what allows pensions and age pensions to overlap and work together rather than being interchangeable.
The assets test looks at everything you own outside of your home. This includes your superannuation fund, investments outside super, as well as everyday assets such as your car, boat if you have one, and even household items worth something you could realistically sell today.
Income testing works differently. It counts income from all sources but does not use your actual returns when it comes to your financial assets such as your pension funds, stocks, managed funds and cash. Instead, a simple assumed rate of return is applied, called the consideration rate.
This acceptance rate is deliberately set quite low, often well below what people actually earn over time, and it means you don’t need to report every dividend, interest payment or market movement. It makes the system simpler than it could be.
When you put these two tests together you get an interesting result. Two people can have the same total assets but receive different age pension payments depending on how much of those assets are financial and how much are other assessable items.
And importantly, old-age pension doesn’t just end when you exceed these thresholds; becomes increasingly thinner. Under the means test, for every $1,000 over the cap your pension is reduced by $3 every fortnight. According to the means test, for every dollar of income above the free space, it decreases by 50 cents. Whichever test results in a lower pension is valid.
So what does this actually look like in real life? I’ll show you a few examples so you can see how the system behaves for singles and couples who own a home versus someone who rents.
And to be clear, this isn’t about encouraging anyone to spend their retirement or stop saving. It’s about helping people with low balances feel more secure, and it’s about helping people with high balances think a little more strategically about how to turn those savings into income.
Let’s start with a homeowner couple. A couple with total assessable assets of about $503,000 might have about $473,000 in retirement funds and investments and about $30,000 in things like cars and household items.
If they withdraw 5 percent of their retirement income, that gives them about $23,650 a year. Since they are still close to the full-age pension zone, they can also receive around $45,386 per year in pension. This gives them a total income of approximately $69,000 per year.
Now compare that to a couple with $1 million in assets. They might have invested around $970,000 and could invest the same $30,000 in other assets. Taking out 5 percent gives them $48,500 a year in retirement.
But old-age pensions are falling rapidly, falling to about $6,600 a year. So their total income is close to $55,000 annually. In other words, they have nearly half a million dollars more in savings but earn less income at the same rate of reduction. This is the sweet spot in the action.
You see the same pattern for singles.
A single homeowner with around $342,000 in total assets might have around $312,000 in super and $30,000 in other assets. Taking 5 percent would give them about $15,600 a year, and they could still collect about $29,600 in old-age benefits. This works out to about $45,000 per year in total income.
Compare this to someone with $700,000 in assets. They might be getting about $33,500 in pension, but their pension drops to about $1,700, leaving them with close to $35,000 a year. Again, they have more capital but receive less income than a combination of old-age pension and pension with the same deduction rates.
But their situation is not worse. Someone with a larger pension may choose to withdraw more from it each year to increase their income. And over time, as pension balances decrease, age pensions may rise again as they move back to thresholds. Please remember this.
The cap is higher for a single person who is not a homeowner because they are allowed to have more assets before their pension is reduced. A single non-homeowner with around $663,000 in assets might have around $613,000 in super and $50,000 in other assets.
With a 5 percent deduction rate, this provides about $30,650 a year in retirement plus about $24,700 in pension benefits. This means total annual income is approximately $55,000.
But someone with $900,000 in assets and withdrawing the same 5 percent could receive about $42,500 in retirement and only $6,200 in pension, for a total of closer to $49,000. So again, it’s more savings, but not necessarily more income from the same pension deduction rate.
This doesn’t mean you should aim to be less into retirement. This means people with mid-level super balances need to stop assuming they’re headed for a second-class retirement just because they don’t have a seven-figure super balance.
The real lesson from this is that retirement income in Australia is tiered. The amount you have in Super is important. The amount you will be entitled to from age pension is also important.
Working can also make a difference in your earnings. And when these pieces work together, the total retirement income available to someone with a lower or moderate super balance can be much better than people expect.
A large number of pre-retirement Australians think there is something to be ashamed of about accessing age pension or that it is only available to people with next to nothing. This is absolutely not true.
Age pensions are a fundamental part of the pension system and work very well alongside pensions for many retirees. And many use it as their base layer and most reliable source of income, supplementing it with their super balance and income from work.
In fact, nearly two-thirds of retirement-age Australians rely on either a full- or partial-age pension as part of their income when they reach age 67, if they are eligible.
Once you understand this, you can stop focusing on creating the greatest balance possible and start focusing on how the retirement system actually works, so you can create the most effective layers of income and adapt to changing rules over time. These are not always the same thing.
Bec Wilson is the bestselling author How to Have an Epic Retirement and new releases Prime Time: 27 Lessons for the New Middle Life. Writes a weekly newsletter epicretirement.net and hosts prime time podcast.
- The advice given in this article is general in nature and is not intended to influence readers’ decisions about investments or financial products. They should always seek their own professional advice, taking into account their personal circumstances, before making any financial decisions.
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Bec Wilson is the author of How to Have an Epic Retirement and writes a weekly newsletter for pre- and post-retirees at epicretirement.net.
