Should I Convert My Super to a Pension?  – Guidance Financial Services

I’ve had several questions in the Ask an Expert column recently centred around the wisdom of converting superannuation into a pension. This conversion is generally presented as something that requires minimal thought, almost just a default action. But judging by the volume of questions I get on this topic, and the complex scenarios that people face in the real world, the question of whether a superannuation account should be converted to a pension is less straightforward than it may perhaps seem. So I thought this week in the blog I would dive into a little bit of detail on where the standard default thinking might require some nuance. 

There are two primary circumstances where you may be contemplating shifting from the accumulation phase of superannuation into the pension phase. Either you are retiring, and need to generate income to replace your former wages, or you’re still working but have turned 65. There is a third scenario, for those between 60 and 65 years of age, which concerns transition to retirement, however the benefits of this strategy are marginal for most people these days, so for today I’m going to set that situation aside. 

Should I convert my super to a pension when I retire? 

This is the situation most people envisage when considering the move from accumulation to pension. You’ve retired, and it’s now time for superannuation to do its job. You need regular income to replace your former wage, and superannuation is the solution. For the vast majority of people then, converting to a pension at this time is absolutely the right way to go. As mentioned in the intro though, judging by the number of questions that I get around this topic, assuming that this is the right answer for everyone is overly simplistic. There is a significant portion of the population for whom it’s not quite so simple. 

The main exception to the conventional wisdom here is for those people who have a lifetime income stream via a defined benefit super fund. Most often these are former government employees, perhaps from defence or public servants. The income being provided from their defined benefit fund is comfortably covering all their needs, and so they question the benefit of converting their lump sum super funds into another income stream that they simply don’t require. 

It’s worth flagging here that when you convert your superannuation from the accumulation phase to the pension phase, there are two primary consequences. The first is that the tax treatment on earnings and capital gains changes. Whereas there was a small amount of tax payable whilst in the accumulation phase, once you’ve shifted across to the pension phase, there is now no tax payable. 

In addition, once you are in the pension phase you must draw out a minimum amount each year. That minimum drawing amount is a percentage of the balance with the percentage adjusting as you age. Between age 65 and 75, the minimum drawing requirement is 5% of the balance. 

Shifting your accumulation superannuation savings into a tax free environment is obviously attractive. But for people who don’t require any additional income, the necessity to draw a pension often has them questioning whether this is indeed a smart move. 

The issue then becomes what you do with this surplus pension income if you do make the conversion. If you build it up in savings, and perhaps invest it, then eventually the tax on those earnings will outweigh the savings produced by having moved your accumulation into the pension phase. Now that will take some time, quite possibly 10 years or more, but nonetheless it will eventually happen. If this is your expected outlook, then there is certainly an argument to be made that you would be better off leaving the funds in accumulation so that they can simply compound and grow. Sure, there will be some tax paid on the earnings, but if you have other wealth, it is probable the tax rate within accumulation in superannuation is lower than your alternative tax options. 

The other attraction of leaving your funds in accumulation is the simplicity. I have clients who have both a pension and an accumulation account. The pension account gives them the income that they need, whilst their accumulation account is for some sort of purpose later in life, usually either to provide for aged care needs, or to leave something behind for the next generation. We know that the accumulation account could be converted into a pension at any moment, but until then, it’s quite effortless to just have that investment pool ticking over, and although it pays a little bit of tax, the investor at least doesn’t need to worry about lodging tax returns or dealing with accountants.  

Should I convert my super to a pension because I’ve turned 65?

We’ve made great strides in living longer and healthier lives, and as a consequence many people are choosing to remain in the workforce longer. Current superannuation rules provide that upon reaching 65 years of age you are able to access your superannuation savings irrespective of whether you have retired or not. This therefore leads to some questions around whether a conversion to pension should be instigated, even whilst the account holder remains in the workforce, earning regular income. 

This is a reasonably similar situation to the person with the defined benefit income stream. Again it largely depends on what you will do with the pension income if you make that conversion. If you aren’t already making maximum concessional super contributions, then perhaps this pension income might enable you to do so, and this might produce a favourable tax outcome if your wages income is beyond $45,000. You could even potentially put the funds in as after-tax contributions, non concessional is the jargon, if you have room within the various limits. 

Most frequently though, I find people prefer to keep their money in accumulation and not commence a pension, until they actually retire. They are usually working on in their late 60s because they want to strengthen their financial position. Often they might have suffered a bit of a setback, such as a separation, or a business that didn’t go to plan. Seeing money come out of superannuation goes against the whole thrust, so whilst there is a small tax differential, the desire to continue to accumulate outweighs that consideration. 

In both circumstances here, I’ve referenced the key deciding factor being what use the pension income is going to be put to. If it is the case that the superannuation savings are simply eccess to your needs, then when you’re gone, they will be distributed to the beneficiaries in your Will. One consideration could be to convert to a pension and then progressively make those gifts now whilst you are still alive. In this way you get to see the benefits that this money produces for those around you, and perhaps the impact is greater where you’re passing money on to your adult children who are trying to raise their own family. I’ve even had someone explain to me that the reason they make early inheritance gifts is purely out of self-interest. By doing so, their children are able to afford to live close to them, which means they can have lots of interaction with their grandchildren, and have the comfort of knowing that come later life they’ll have family nearby. Something worth thinking about.