Suncorp Life's Sarina Raffo considers the pros and cons of superannuation and non-superannuation income streams and what affect this will have on retirement.
In recent years there has been a growing sense of disenchantment among consumers with superannuation. And there are a few key reasons for this:
- the market crash – markets, along with super fund balances fell 35-45 per cent during the global financial crisis (GFC) and are yet to fully recover;
- legislative risk — constant tinkering with the super rules by Government has left people cynical;
- member disengagement — people don’t see super as ‘their’ money, as it’s locked away until retirement and is seen as overly complex.
These factors, along with the reduction in the concessional contributions limit; the receipt of redundancy payments and inheritances, and the propensity of people to invest in property means it is likely that people will increasingly accumulate wealth outside their super.
Of course, superannuation isn’t the only retirement savings vehicle.
Other assets such as managed funds, direct shares and investment property can similarly be used to generate retirement savings.
With the median balanced super fund returning just 4.51 per cent per annum over the past 10 years, who could blame people for thinking they could have done better putting their money elsewhere?
In this column, I will put superannuation (allocated pensions) and non-superannuation income streams (managed funds) in retirement to the test in the context of:
- taxation;
- social security; and
- other considerations.
Taxation
Income Tax
Superannuation – allocated pensions
Income from assets supporting an allocated pension is tax-free. For individuals aged between 55 to 59 years of age, pension payments are taxed at marginal tax rates, with provision for a tax-free amount and a 15 per cent offset.
This effectively means that people can receive up to $48,158 tax-free. The taxable component of lump sum withdrawals is tax-free up to $160,000 and taxed at 15 per cent plus Medicare levy on amounts above $160,000.
For individuals aged 60 and over, pension payments and withdrawals are completely tax-free.
These individuals do not need to include pension income or withdrawals in their tax return, thus lowering their taxable income, and potentially lowering the tax paid on any other income.
Non-superannuation – managed fund
Managed funds generally provide a combination of income and the potential for capital growth. Income distributions can generally be reinvested or taken in cash. Re-invested income forms part of assessable income for tax purposes.
And income distributions may include imputation credits. Individuals can receive up to $16,000 in income, tax-free, outside superannuation. This may be even higher where imputation credits are applied.
Capital Gains Tax (CGT) Superannuation – allocated pensions
Capital gains from assets supporting an allocated pension are tax-free.
Super fund investors – particularly those in self managed super funds (SMSFs) – can control the timing of disposal of CGT assets to minimise CGT.
Non-superannuation – managed fund
A capital gain is incurred on any sale of assets in the managed fund.
Income distributions will include a portion of realised capital gains, which must be included in the investor’s taxable income. However, investors have no control over the timing of the disposal of CGT assets.
Imputation Credits
Superannuation – allocated pensions
Imputation credits derived from investment in Australian shares flow to the super fund. Their full value is credited to the pension account (as there is no taxable income to offset).
Super fund investors (especially those in SMSFs) can control the amount of imputation credits they can earn by choosing shares paying higher fully franked dividends.
Non-superannuation – managed fund
With a managed fund, the imputations credits flow to the investor via income distributions, and they must be included in the investor’s taxable income.
Any excess credits (where taxable income exceeds their effective tax-free threshold) can be fully refunded to the investor.
However, those who invest in Australian companies via managed funds have no control over the level of imputation credits they may earn because it is the fund manager who controls the investment decisions.
Table 1 summarises the taxation of allocated pensions and managed funds.
Imputation Credits
Full value refunded (as no tax liability to offset)
Can increase the amount of tax-free income.
Centrelink
Centrelink generally assesses superannuation allocated pensions more favourably than non-superannuation income streams, potentially resulting in increased entitlements.
An allocated pension is fully assessed as an asset, however; only a portion of the income is assessable under the income test.
In contrast, financial investments, for example, managed funds are fully assessed under the assets test and are deemed to earn a certain amount of income, regardless of the amount actually earned under the income test.
Another point of difference to consider between super and non-super income streams in the context of the age pension is taxation.
For individuals in receipt of the age pension, the age pension is included in taxable income along with income from a managed fund, thus reducing the amount of tax-free income that can be earned.
However, the income from an allocated pension received by an age pension recipient is entirely tax-free.
Other considerations
A practical concern just before retirement is whether an investor in a non-super investment such as a managed fund should cash in their investment and contribute the proceeds into super to commence an allocated pension.
However, there are a number of factors to consider when making such a decision:
- eligibility to contribute to super
- the contribution limits
- the amount of CGT payable on disposal of the non-super investment
- the ability to claim a tax deduction for superannuation contributions to offset CGT liability, and
- Centrelink assessment.
Table 2 compares superannuation and non-superannuation investment before and during retirement.
Case Study
Laura (aged 60) determines that she needs an income of $35,000 per annum for a comfortable retirement.
We compare how she could do this using an allocated pension (superannuation) and a managed fund (non-superannuation).
Option 1 – Managed fund
Laura’s investment income and regular payments would be taxed at her marginal tax rate. So Laura would need to draw $41,916 pa to receive an after-tax income of $35,000 pa.
Option 2 – Superannuation allocated pension
Super pension payments are tax-free from age 60. Therefore, Laura needs to only withdraw $35,000 pa from her allocated pension to receive an after-tax income of $35,000 pa.
Conclusion
For many people, superannuation can be more tax-effective than an equivalent non-superannuation investment.
The overall tax paid on superannuation is generally less than that applying to personally held assets.
To address the downsides of super, it may be optimal to have a mix of super and non-super investments.
Sarina Raffo is a technical services consultant at Suncorp Life.
