The pillars of retirement income
While older Australians are reportedly among the wealthiest retirees in the world, much of their wealth is tied up in their family home, leaving many to worry about how they will find the money to pay for their day-to-day expenses when they stop work.
This fear is made worse by estimates from the Association of Superannuation Funds of Australia that the minimum cost of a comfortable retirement for a single person in Australia is roughly $50,000 a year, while for couples, it’s $70,482.
During the past two decades, Australians have been able to rely on the so-called ‘Three Pillars of Retirement Funding’. These include the age pension funded by the Federal Government, compulsory superannuation and voluntary savings.
However, a recent ‘Household Capital: Your Life Choices’ survey, published by research house MorningStar, showed 85 per cent of all retiree respondents are unaware of these three potential sources of income through retirement.
This is significant given that preparation for retirement should start at least ten years before your planned retirement date to optimise your financial situation.
But what exactly does that all mean, and why?
Most retirees understand the concept of the age pension:
- that it is asset-tested and income-tested;
- that once you qualify for it, it will likely be paid to you for life;
- that it is indexed for inflation; and
- has no risk associated with it.
It is a fantastic safety net for all Australians, providing them with a regular, if modest, income throughout their retirement.
Any other assets you hold or inherit through retirement can further boost this income. However, the more assets you own, the smaller your pension entitlements will become until you are not eligible for any age benefits.
This is where it is crucial to start planning early.
For many Australians, the full potential of superannuation is yet to be seen, given that compulsory superannuation only really spread through the community some twenty years ago, and many older Australians still have relatively modest superannuation balances.
Superannuation, though, still remains a central pillar of retirement planning, as once a private pension commences from your superannuation account all the assets supporting that pension, in terms of capital gains and income, become tax-free. The income paid from your super account is also tax-free.
The biggest issue for retirees, however, is that strict rules surround when you can contribute to super and how much you can contribute when you do make these super contributions.
Most Australians are familiar with the superannuation contributions their employer makes on their behalf, and some understand what is involved with salary sacrificing and how this can be used to reduce their annual tax bill.
Fewer, though, understand they can contribute up to an extra $110,000 annually to super with after-tax dollars. And if they downsize their family home, they can contribute $300,000 over and above their other contribution limits.
These rules are essential because, as many retirees are learning if in retirement their only assets are their home and their savings within super, then they may never need to lodge a tax return or pay tax again.
This can be a big issue for retirees looking to hold assets outside of super, such as investment property or other savings, and
who were hoping to use these assets to help support themselves through retirement.
Without adequate planning in the years leading up to retirement, they may find they cannot squeeze these savings into superannuation, or at least not as quickly as they hoped, and they end up paying needless tax bills.
As a result, it has never been more important to plan for your retirement as early as possible and obtain sound financial advice on how to structure your finances in retirement, as the penalties for getting it wrong can be significant.
Sources:
https://treasury.gov.au/ “Retirement Income Covenant”, Household Capital, August 2021.
https://treasury.gov.au/ “Retirement Income Review Final Report”, The Australian Government the Treasury, July 2020.
https://www.superannuation.asn.au/ “ASFA Retirement Standard Summary”, The Association of Superannuation Funds of Australia (ASFA), March 2023.
https://www.firstlinks.com.au/ “Solutions to unite the three pillars of retirement funding”, Joshua Funder, Firstlinks, 8 December 2021.
