Prime Time Financial Counsellors Pty Ltd: Summing up - and a brief look at the alternatives

Summing up - and a brief look at the alternatives

Account based pensions should be considered by anyone who wants to receive a flexible, tax-effective income stream in retirement. They offer many advantages - and a few disadvantages - compared with other alternatives you might consider.

In this page we sum up the pros and cons, and take a brief look at some other options.

ADVANTAGES

Tax Advantages

There's generally no lump sum tax to pay when you roll into an account based pension. This means the full amount of your rollover is available to provide for your pension income.
The investment earnings added to your account by the superannuation fund are tax-free.
The part of the pension payment representing the return of certain rollover components (the deductible amount) is tax-free.
You may be entitled to a tax rebate.
Tax is deducted on a PAYG basis, so you don't have to put money aside to pay a tax bill at the end of the year.
The trustee provides you with a group certificate every year, which makes it simple to complete your tax return.
From age 60 years your income will be tax exempt income.

Professional Management

Account based pensions are generally provided by professional fund managers who manage the investment on your behalf.
You can usually choose from a range of investment options covering cash, fixed interest and growth investments like managed funds and shares.

Flexibility

You can vary the amount of pension payments you take each year.
You can make additional lump sum withdrawals.
If you die, your remaining account balance isn't lost. It's paid in full to your dependents, either as a continuing pension or a lump sum, or to your estate.

DISADVANTAGES

There is no guarantee that your pension payments will continue throughout your lifetime.
You generally can't split your pension payments with your spouse to reduce tax.
An account based pension does not qualify as a complying pension.
An account based pension is not exempt from the assets test for social security purposes.

What are the Alternatives?

If you have a lump sum super payout (or rollover) and you want to use it to provide your income in retirement you can:

purchase a fixed payment pension or annuity; or
pay lump sum tax and invest in your own investment portfolio; or
if you are not yet 65, invest in a rollover fund and draw down lumps sums as you need them.

The following table compares the features of account based pensions with some of these different investment strategies. It is only an overview and is not meant to be a comprehensive comparison.

ALTERNATIVES TO ACCOUNT BASED PENSIONS

	Account Based Pension	Term* Annuity 100% RCV	Life Annuity Nil RCV	Cash Your Lump Sum & Purchase an Investment Portfolio
Can you defer lump sum tax?	Yes	Yes	Yes	No
Are your income payments guaranteed?	No	Yes	Yes	No
Do you have a choice of investment portfolios?	Yes	No	No	Yes
Can you get a tax rebate on par of your income?	Yes	Yes	Yes	No
Do you have access to your account balance at all times?	Yes	No	No	Yes
Is income guaranteed for life?	No	No	Yes	No
Are regular payments flexible?	Yes	No	No	Yes

* For an explanation of these terms go to the Glossary page.

Life Pensions and Annuities

While life pensions and annuities can provide you with greater certainty, one of the difficulties with them is that you are usually locked into a level of income that's determined at the time you purchase them.

This is because the life insurance company locks in pension and annuity rates based on investment conditions - especially interest rates - at the time.

Despite these limitations, lifetime pensions and annuities can be useful. One strategy could be to use an account based pension initially and transfer amounts to an annuity when life pension or annuity rates are considered desirable.

Complying Income Streams

To obtain a social security assets test exemption (ATE) a complying income stream must meet a number of set criteria. Below are key criteria and features of complying income streams. Note: With limited exceptions ATE reduced from 100% to 50% from 20/9/2004.

Term Allocated Pensions

Can be purchased at any age.
Income payments vary annually based on account balance and a payment factor (PF) related to the remaining term.
The term established at commencement must be either:
- Between the investor's life expectancy (LE)* and their LE* if they were up to 5 years younger.
  
  Or, if the investor specifies that the income stream will automatically revert to a spousewith a longer LE they may choose a term based on their own LE (above) or:
- Between the spouse's LE* and their LE if they were up to 5 years younger.†
Note: a spouse includes a married or de facto partner but not a same sex partner.

Lifetime^

Can be purchased at any age.
Income payments are fixed except for indexation (capped at greater of CPI +1% or 5%).
The maximum guarantee period is 10 years (for those commenced before 1/9/2004) or the lesser of 20 years or LE if commenced after that date. For joint lifetime, longer LE may be used.
Payable for investor's life and, if applicable, automatic reversionary's life (unless a child <16 or a student <25) or joint owners' lives.

Life Expectancey (Fixed Term)^

Since 20/9/2004 can be purchased at any age, but before that date only after Age or Service Pension age.
Income payments are fixed except for indexation (capped at greater of CPI +1% or 5%).
Before 20/9/2004 the term was equal to LE* or, if LE exceeded 15 years, between 15 years and LE*. Since 20/9/2004 the allowable term is the same is the same as for Term Allocated Pensions.
Since 20/9/2004 couples (married or de facto but not the same sex) may purchase a joint income stream for ATE purposes provided that each is the reversionary of the other with the term determined under the same conditions as a Term Allocated Pension.

Common Criteria Include:

No Residual Capital Value
Genarally, non-commutable except in the first 6 months of a non-commutation funded complying income stream, to pay a surcharge liability, on death or, to purchase another complying income stream.
Purchase price must be wholly converted into income.
capital must not be used as security for borrowing.
Cannot be transferred except on death.
Reversion/commutation value cannot be >100% of the benefit immediately prior to reversion/commutation.

	*	Life expectancy is rounded up to the nearest whole year.
	^	Lifetime and life expectancy pensions can only be commenced in a SMSF in limited circumstances.

Income Splitting

If you want to split your income with your spouse then you will need to hold some investments in each of your names. To achieve this, it may be beneficial to pay lump sum tax on some of your superannuation and invest the proceeds in a portfolio of investments, some in your name and some in your spouse's.

Income splitting can be a tax-effective strategy for a couple since it allows you to make use of your spouse's tax-free tax thresholds as well as your own.

Consider Your Priorities - and Take Professional Advice

Your decision will depend on what's most important to you.

If a guaranteed indexed income for life is your major requirement, then a fixed payment pension or annuity product may be attractive. On the other hand, if flexibility is more important then an allocated pension or your own investment portfolio might be more attractive options. Sometimes a combination of different strategies can achieve the best outcome.

The best way to work through the issues is to sit down with a professional financial adviser. They'll be able to talk you through the pros and cons and arrive at the best solution, taking account of your objectives and your personal preferences.

Take the opportunity now to contact Prime Time using the Contact button in the menus above and ask to talk to one of our financial advisers.

Reproduced with the kind permission of Macquarie Investment Management Limited