One of the costliest and most common problems with superannuation is failing to appreciate the difference between the accumulation and pension phases for your account.
An incredibly high estimated number of 700,000 Australians keep their super in the accumulation phase long after they have actually retired, thereby exposing themselves to the 15% earnings tax on accumulation funds.
By contrast, super funds in pension mode are entirely tax free, which is a substantial benefit over time.
Psychology Can Cause this Mistake
Often, this mistake comes about through a couple of fundamental misunderstandings and also a psychological issue as well.
Starting with the psychological issue, many people entering into retirement are justifiably anxious about the whole process.
They may be in denial about the fact that they are retiring and are hoping to land another job or they might be put off by the “pension” term, which they might associate with elderly people reliant on government payments.
The thing to realise here is that the only thing that is changing is the tax treatment of your super savings – there is no prohibition on getting another job and there is no relationship at all with applying for the age pension, despite the confusing mix of terms.
Overcoming the Stumbling Blocks
There are, however, a couple of stumbling blocks that many people encounter and which can cause reluctance to take the plunge and move their fund out of accumulation phase and into drawdown.
One is an understandable reluctance to prematurely start “using up” their nest egg, which has been built up over a lifetime.
They may feel that they don’t need the income produced by their super, relying instead on other savings or employment and don’t want to start turning on the income tap too early.
What retirees need to realise is that their super is highly likely to continue growing even when they are drawing down on it – particularly in the early years before the age of 65 when the compulsory drawdown level is just 4%.
Indeed, it is possible that the amount of tax they are saving is equal or higher than the amount they would end up drawing down.
Naturally all of this varies according to the investment mix chosen and the performance in a particular year but in almost all cases it is preferable to switch super to the drawdown phase as soon as you are able to.
It is also possible to recontribute the super pension payments back into super if the income is not needed, depending on contribution limits, of course.
This can be done by starting up another accrual fund which is needed because new contributions can’t be made into a fund once it is in pension or drawdown mode.
Running Two Accounts a Good Option
There is no problem running two separate accounts with one in accrual and the other in pension mode – indeed it is quite common now as many retirees move to having multiple income sources from investments inside and outside super and from working.
This is an important consideration if you want to keep working either full time or part time but have reached a condition of release by leaving a job or reaching the age of 65.
While normally it is better to consolidate down to one account to keep fees as low as possible, retirement and semi-retirement is a time when it can be good to have two accounts.
Having a larger fund in drawdown mode means you will need an active accrual account to have super contributions paid into by an employer.
The usual fund selection criteria of looking for low fees and a good long term investment performance now apply to both funds, although many people opt for a slightly larger cash component in the early years after they have retired – particularly for the drawdown fund.
While maintaining the most aggressive investment setting you can without losing sleep is usually the best option for most people, sequencing risk in which a few bad consecutive years of investment returns can permanently impair your retirement is worth avoiding by keeping larger than normal cash buffers.
This allows enough income without the need to sell down growth assets at an inopportune time.
