Figuring out retirement income in Australia (pension account vs aged pension)

It's time to talk about something we all hear a lot about but might not fully understand: pensions.

Now, if you're like many people, you might think you know what a ‘pension' is, but what if I told you that the term could mean multiple things?

Suddenly confused?

You're not alone.

Today, we're zeroing in on Pension Accounts and Aged Pensions.

These might sound similar, but they're not the same thing.

And understanding the difference could significantly impact your quality of life in retirement.

So, if you want to make smarter financial decisions for your future, you're going to want to stick around for this one. Let's dive in.

When it comes to planning for retirement, understanding your options is crucial.

Yet, many people I talk to are uncertain or a bit unsure about planning for retirement here in Australia.

Now I know we might not all be ready to wrap up and retire anytime soon, so why should you care?

Well, navigating your retirement income isn't just a ‘future you' problem.

It's a ‘right now' question that can affect how comfortably you live in your golden years.

No matter if you're 40, 50, or 60, it's never too early or too late to plan.

And to get your information right.

For example, there's a common misconception as to what age you actually retire at.

Some people say 60, some 65, some 67.

Firsly, there is not set age that you need or should retire.

It's really something that will be based on your financial situation.

Secondly, most of the time we talk about these ages they are based off what age you get access to certain pension types.

To make it clear – you can actually access your super from the age of 60, but you have to wait until you're 67 at the moment for the aged pension to become available.

It's important to know the rules of the game if you want to play it well.

That's why I want to focus on unpacking Pension Accounts and the Aged Pension.

You're about to find out why they're both important and also why they're not interchangeable.

What is a Pension Account?

Let's kick things off with Pension Accounts.

Now, you might be familiar with superannuation—your good ol' super fund that you've been contributing to throughout your working life.

Well, a Pension Account is an extension of that.

Also known as a retirement income stream, because that's what it provides.

It's a specific type of account you set up within your super fund to give you a regular income during retirement.

It's not about taking all your money out as a lump sum and figuring out what to do with it.

It's about turning your super balance into a steady stream of cash.

Here's where the numbers kick in:

You can typically start one of these accounts when you reach your ‘preservation age,' which varies between 55 and 60, depending on when you were born.

In terms of tax incentives, a Pension Account often comes with a sweet deal.

Once you hit 60, the income you draw from it is usually tax-free.

That's right, tax-free.

It’s not just about what you earn; it’s also about what you get to keep.

The annual minimum withdrawal is currently 4% of your account balance for those under 65, and this rate scales up as you age.

Say you've got a Pension Account with $500,000.

A 4% minimum withdrawal means you'll need to take out $20,000 in the first year.

The remaining 96% sits there, potentially invested in something that earns more than 4% meaning you'll never need to dip into your balance (plus a bit more for inflation).

If you live another 25 years, and if your investments don't grow to cover those withdrawals and inflation, well, you're going to run out.

And remember, the withdrawal rate scales up as you age, meaning you'll need to withdraw even more in later years.

The sooner you start looking at turning your standard super accumulation into a Pension Account, the more options and flexibility you'll have in retirement.

Waiting until the last minute is like trying to do your Christmas shopping on Christmas Eve—you'll end up settling for what's left, not what's best.

A Pension Account gives you a lot more control over your income post-60, but with that control comes responsibility.

You've got to manage your investments wisely and be prepared for market ups and downs.

If you want to know more about this account, I highly recommend you can talk directly with your super fund to map this out a bit more.

What is an Aged Pension?

Alright, moving on to Aged Pensions.

These are a different beast altogether.

This is a regular payment from the government that kicks in when you meet certain age and financial requirements.

It's going to be all about whether you meet the criteria set by the Australian government.

Firstly, you must be at least 67 years old to qualify.

Then there are the financial tests, including income and asset tests.

A homeowner couple can have assets up to $401,500 (as of September 2022) and still receive a full Aged Pension.

When we talk assets – these are things like shares, super balance, cares, contents and things you own.

The best thing about this test though is that your home is not included in your asset test.

So you can have a $ 10 million home, $350,000 in assets (like super), and still receive a full aged pension.

This isn't to say it's a loophole for the rich, but more a point as to why owning a home in Australia is so favourable in retirement.

Exceed the $400k or so in assets then the amount of pension you receive starts to reduce.

Go above $876,500 in assets, and you're not eligible at all.

In terms of what you receive as a pension the maximum basic rate for a single person is $952.70 per fortnight.

For couples, it's $1,436.20 per fortnight combined.

Now, that might cover your basic living costs if you're frugal, but here's the thing—it's actually very close to the poverty line.

The Organisation for Economic Co-operation and Development (OECD) estimates that the poverty line for a single adult in Australia is around $23,000 per year.

If you rely solely on the Aged Pension, you're looking at an annual income of roughly $24,770.

See how close that is?

The point I'm making here is to consider the Aged Pension as a safety net, not a trampoline.

It's meant to catch you if you fall, not bounce you into a comfortable lifestyle.

Too many people think that the Aged Pension will suffice for all their retirement needs, but unless you plan on drastically cutting back on pretty much everything, it's not going to be enough.

Why You Should Plan for Both

Planning your retirement isn't a one-size-fits-all affair.

I always tell people your retirement income should ideally be sourced from a three-legged stool of savings, super, and pensions.

Miss out on one, and you're in for an uncomfortable seat.

Three sources of income means you have options.

The Aged Pension as an income source alone is only barely above the poverty line.

Here's my tip no matter what lifestage you are in: start planning now.

I've talked to folks who thought they'd just wing it in retirement.

Most of them regretted not laying the groundwork earlier.

A bit of planning today can make a massive difference down the line.

I know many people avoid looking cause they are nervous about what realities they might find, but you might as well get the awareness so you can give yourself as many options as possible and feel less forced or limited in retirement when income is harder to come by.

Common Pitfalls to Avoid

Alright, let's talk about mistakes—so you can avoid making them.

1. Last-Minute Planning: Don't be the person who thinks they can sort it all out at 67. It's never too late to start, but earlier is better.
2. Assumptions: Many think they're too young or too poor to start planning or that they need millions to retire comfortably. This isn't the case and a simple bit of research and assessment of your financial status can paint a really solid picture.
3. Not Understanding the Basics: Pensions aren't just for policy people or finance nerds like me. Get to know what you're entitled to and how you can maximize it. The ATO is a great database and they are improving the way they explain it all on their site.

I've seen too many people just accept their circumstances because they feel it's too late to change anything.

Reality check: It's often not.

Take some control over your financial future.

Conclusion

Yes, pensions can be complex, but they're far from impossible to understand.

Knowing the ins and outs of Pension Accounts and Aged Pensions can be your golden ticket to a comfortable retirement.

And remember, you don't have to go it alone.

There are experts, resources, and yes, even articles like this one, to help guide you.

So, as you ponder your retirement plans, think about the Pension Account and the Aged Pension.

Understand them, plan for them, and then enjoy the rewards that come from being financially savvy.

You've earned it.