Pension labyrinth

The first question everybody asks on facing retirement is, "how much do I need?"

There is no simple answer, because the amount depends on a range of variables that include how long you will live, your health, the performance of your portfolio and the rate of inflation.

A general rule of thumb is 12 to 15 times your annual expected expenditure, but the numbers are further complicated because your eligibility for Centrelink benefits increases as your assets reduce.

For instance, a home-owner couple with $950,000 of assessable assets may qualify for a pension of $123.50 a fortnight.

However, if those assets were run down to $600,000, the pension would rise to $648.50 a fortnight.

At the very least it's important to be up to speed on the rules, benefits and strategies available to you.

ACCESS RULES

Unless you find it necessary to access your super under the hardship provisions, it is locked up until your preservation age.

This is 55 for people born before July 1, 1960, and then rises in steps until it becomes 60 for people born on or after July 1, 1964.

However, even if 55 is your preservation age, you cannot access your funds before 65 unless you trigger a condition of release.

Between the ages of 55 and 60 you need to satisfy the trustee of your fund that you intend to retire permanently and intend never to be gainfully employed for 10 hours or more each week. This does not forever prohibit you from going back to work, because after a reasonable absence from your job you are entitled to have a change of heart and resume employment.

Once you reach 60, you can trigger a condition of release by resigning from a job - it need not be your main job.

At 65 you are free to access your super and can even contribute for the next 10 years if you satisfy the work test.

If you are a part-time worker you must be gainfully employed for at least 10 hours, and less than 30 hours in the week you make the contribution.

TRANSITION TO RETIREMENT

There is a clever strategy that enables people aged 55 and over to access their super prior to their preservation age even if they are working, called transition to retirement.

It was introduced to enable people to reduce their working hours yet stay in the workforce (although there is no need to reduce your working hours to take advantage of it).

It's simply a matter of increasing your salary-sacrificed contributions to super to the maximum, and then compensating for the decrease in take-home pay by drawing a pension.

Take an employee on $100,000 a year whose employer contributes $9000 in compulsory super.

It is well short of the $25,000 the employee can contribute as a concessional contribution.

Suppose the employee reduces their income to $84,000 by salary sacrificing an additional $16,000 a year to super.

Yes, their take-home pay would reduce by $10,080 but the net contribution to super would be $13,600 after deduction of the 15 per cent entry tax, leaving them $3520 better off.

CENTRELINK AND AGE PENSION

Money in super isn't counted by Centrelink until the pensionable age is reached. This is 65 for men born before July 1, 1952, and 64? for women born between July 1, 1947 and December 31, 1948. Where couples have a big age difference they should take advice, otherwise valuable Centrelink benefits could be lost.

Take a husband, 65, and a wife, 58, with assessable assets of $650,000.

Let's say the wife retires and receives a super payout of $450,000 and starts an account-based pension to enjoy the tax benefits.

As a consequence of this, the husband would immediately lose his Centrelink benefits because her super is now counted.

Had she left the money in the accumulation phase, he could have continued to enjoy a part-age pension.

When assessing eligibility for the age pension, the super balance is assessed under the asset test, while for income-test purposes the income from the fund is based on a formula that takes into account the life expectancy of the superannuant.

Take a couple aged 66 and 65 who have their own home, $25,000 in lifestyle assets such as furniture and car, as well as his super of $300,000, which is now in the account-based pension phase. His life expectancy is 17.76.

The exempt amount for Centrelink income-test purposes is found by dividing his super account balance by his life expectancy.

In this example it is $16,892.

As a result, the first $16,892 of his account-based pension income is not assessed for the income test.

The minimum amount that is currently required to be drawn from his super fund is just $11,250 a year, which means he could draw even more than the required minimum without being affected under the income test.

Anybody who believes they are eligible for the age pension should take advice well before they reach pensionable age.

In some circumstances, it may be appropriate to gift assets to family members or a charity in order to maximise Centrelink benefits, as Centrelink only assesses assets that have been disposed of within five years of applying for the pension.

There is no gift duty in Australia, but the decision to give substantial assets to family members should not be taken lightly, as they can be lost for good if the family members who receive them suffer financial problems such as a relationship breakdown or bankruptcy.

As a general rule it is better to help your children when they are younger as long as they are responsible, rather than make them wait until the parents are 90 and the children are 60, when they should not need it. Each case must be decided on its merits.

STARTING AN INCOME STREAM

Every investment strategy has advantages and disadvantages.

The benefit of starting an income stream is that you move to a tax-free environment, but the price is the requirement to draw an increasing percentage as years pass.

The benefit of staying in the accumulation phase is that you are not required to withdraw any money - the disadvantage is the 15 per cent tax on earnings.

Most Australians will have insufficient funds outside super for them to justify staying in the accumulation phase.

But those with large income-producing assets such as property and shares are better off leaving their super in the accumulation stage if their income from sources outside super exceeds $18,200 a year - the point where the 19 per cent tax rate cuts in.

TAKE IT ALL OUT?

The slump in assets caused by the global financial crisis has led to a flood of questions asking whether it's better to take the money out of super and "put it in the bank".

Super is not an asset class like cash, property or shares, but merely a vehicle that lets you hold assets in a low- or zero-tax area. It is also one of the few assets you can own that is not available to creditors if you find yourself in financial strife.

If you only had a small amount in super, say $200,000, there is little point in staying there and incurring the fees that go with super because you would still remain in the tax-free area, even if the money was withdrawn and invested in personal names.

Advice should always be taken before withdrawing funds from super, as it could cause a loss of Centrelink benefits if you are assessed under the income test and drawing an income stream.

If money is withdrawn to pay off debts such as a home loan, there are no adverse consequences for Centrelink benefits because the money is being retained in the household.

Money spent on personal items such as travel and home renovations do not affect eligibility.

Assets such as a car, caravan or furniture will be assessed under the asset test at market value.

There is no limit on the amount that can be withdrawn from super once you reach the preservation age and have satisfied a condition of release.

Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance.

Tax treatment of super: how the rules work

Pre-tax contributions to super lose a 15 per cent entry tax after-tax contributions incur no entry tax. The fund pays 15 per cent tax on its earnings but once an income stream starts, the earnings are tax-free.

Most members' accounts will have both taxable and a non-taxable components. There is no tax on that portion of the withdrawal that comes from the non-taxable component, but between age 55 and 60 there is a tax of 16.5 per cent (including the Medicare levy) on the taxable component that exceeds $175,000.

Once age 60 is reached, all withdrawals are tax-free.

On death, the taxable component incurs a 16.5 per cent tax if left to a non-dependent child. A spouse is always regarded as a dependant.

Therefore, a person age 60 or over, drawing an account-based pension, is living in a money paradise the fund itself is tax-free and, at the same time, they are drawing a tax-free income from it.

Anybody drawing an account-based pension (also called allocated pension) has to draw a minimum amount each year (see above) there is no maximum.