Everyone wants to retire but how does retirement income actually work?
Most of us have superannuation, and most of us understand, in general, how it works.
Your employer puts 9.5% of your wage into a super fund, it’s concessionally taxed, and you can’t access it until you meet a condition of release, usually retirement.
But how many of us understand how superannuation works in retirement?
There are a number of ways in which you can access your superannuation upon retirement.
Firstly, and most unwisely you can access it as a lump sum and withdraw it from super altogether. This is (usually) not a great option as this removes your lump sum from the wonderfully concessional taxed environment that the superannuation provides.
Now, having said that, there are a few circumstances in which withdrawing everything from super might make sense (In some circumstances, if you are leaving your super to your adult children rather than a spouse, but that is a whole other blog topic), but generally speaking, leaving it in the super system is best.
In retirement, you no longer have an employer paying you each week or fortnight, so you need to draw an income from your retirement savings. You may have non super assets like an investment property or shares but typically your retirement income comes from super.
You can arrange a regular payment from your superannuation to your bank account, just like your wage used to be paid.
The most common way to do this would be to convert your ‘accumulation’ superannuation account into an account-based pension. This means that your balance remains invested, exactly the same as your super was if you like, but you begin to draw a regular income from your account. Account based pensions have a mandated minimum draw-down depending on your age. For example, a 65-year-old would draw a minimum 5% of their account each year.
Money drawn from and earnings within an account-based pension are tax free after the age of 60 so it is a very enticing option for retirement income.
Other options for retirement income include annuities, where you hand over your money and get a set payment in return. These can be great if you want certainty of payments as the funds are not exposed to the market, or you want a guaranteed income for the rest of your life, the downside is that you often receive a very low return and cannot access lump sums from your savings if you need it (not without penalty anyway).
What risks exist in retirement?
One of the biggest risks of retirement income is sequencing risk. In accumulation phase, while you are working and contributing to super, downturns in the market, although annoying are not devastating. The market falls, you continue to have your contributions invested in your super and the assets you buy are cheaper than before. When the market recovers you see the full benefit of your investment.
In retirement, you are no longer adding funds to your account, rather, you are drawing them out. This can make losses much harder to earn back.
Losses that have occurred in your retirement income are what is known as sequencing risk. A large drop in your balance at the beginning of your retirement can have a big effect on the longevity of your funds. Whereas a large drop 15 years into retirement will have a much smaller impact.
How do we mitigate this risk? Firstly, reassessing your risk profile. How aggressive should you be with your funds? Maybe taking a step back and investing a larger portion in defensive assets would be a good idea. Secondly, is there a mix of account-based pension, market linked with access to your capital, and annuities, certainty of returns and steady income that could be used?
Thirdly, there are exciting new retirement products available that can give you the best of both worlds. Market linked for a greater chance of returns with a floor or guarantee that they will not fall past a certain point.
Or maybe a mix of all three.
Most importantly getting good financial advice is crucial to help you decide how much to draw, how to allocate your funds, your access to the age pension and managing your ongoing income and investment needs.
Retirement is fantastic, after a life of hard work and saving, being able to stop and enjoy your time is a real treat.
Retirement income doesn’t have to be a minefield, with the right advice you can relax knowing what is coming in and how long it is going to last.
Hit us up with any of your retirement income questions, we love getting ides for new blogs!!
Until next time
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Ben Graham-Nellor is an advisor, coach, blogger and speaker who has worked in the financial services industry for over 15 years. He believes that by educating and advising people today, they can improve their tomorrow.
BGN Financial Management Pty Ltd is a Corporate Authorised Representative 468796 of Professional Investment Services Pty Ltd AFSL 234951 ABN 11 074 608 558 www.centrepointalliance.com.au
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