Why a large super balance can actually reduce your retirement income

People with low to medium super balances often feel like they’re on the outer when it comes to retirement. They look at people with $1 million or more in super and assume those are the people who get to enjoy the ‘epic’ version of retirement, while everyone else just scrapes by.

But that is not how the Australian retirement system actually works.

One of the quirks of the system is that there is a sweet spot where super and the age pension combine very efficiently. In some cases, someone with a moderate level of savings can end up with almost the same income, or even more income, than someone with much higher savings, simply because they still qualify for a far more meaningful slice of the pension.

That sweet spot has shifted again from March 20 because the age pension goes up. And we are not only seeing the standard indexation of the caps, we are also seeing our second rise to the deeming rate in a year.

That changes where the age pension and super combine to give someone with less, more income from the combination of super and the pension, at the same drawdown rate.

The thing to understand is that the sweet spot is not one fixed number for every retiree. It depends on how your assets are structured. The age pension has two key sets of limits. There are thresholds where you qualify for the full pension, and then higher levels where the pension cuts out altogether.

Retirement income in Australia is layered. The amount you have in super matters. The amount you qualify for from the age pension does, too.

For example, at March 20, a single home owner can receive the full age pension with assets up to about $321,500, while a home owner couple can have up to about $481,500. Above those levels the pension doesn’t stop, it gradually reduces as your assets increase.

That’s called tapering. For every $1000 above the assets test threshold, your pension reduces by $3 a fortnight. That tapering is where the magic happens. It’s what allows super and the age pension to overlap and work together, rather than one replacing the other.

The assets test looks at everything you own, apart from your home. That includes your super, investments outside super, and also everyday assets like your car, your boat if you have one, and even your household contents, valued at what you might realistically sell them for today.

The income test works differently. It counts income from all sources but when it comes to your financial assets, like your super, shares, managed funds and cash, it doesn’t use your actual returns. Instead, it applies a simple assumed rate of return called the deeming rate.

That deeming rate is deliberately set quite low, usually well below what people actually earn over time, and it means you don’t have to report every dividend, interest payment or market movement. It keeps the system simpler than it could be.

Put those two tests together and you get an interesting outcome. Two people can have the same total assets but end up with different age pension payments, depending on how much of those assets are financial and how much sits in other assessable items.

And, importantly, the age pension doesn’t just stop when you go over those thresholds; it tapers. Under the assets test, your pension reduces by $3 a fortnight for every $1000 above the cap. Under the income test, it reduces by 50 cents for every dollar of income above the free area. Whichever test produces the lower pension is the one that applies.

So what does this actually look like in real life? I’m going to walk you through a few examples so you can see how the system behaves for singles and couples who own their home, and for someone who is renting.

And, just to be clear, this is not about encouraging anyone to spend down their super or stop saving. It’s about helping people with lower balances feel more confident, and people with higher balances think a bit more strategically about how they turn those savings into income.

Let’s start with a home owner couple. A couple with about $503,000 in total assessable assets might have about $473,000 in super and investments, and about $30,000 in things like their car and household contents.

If they draw 5 per cent from their super, that gives them about $23,650 a year. Because they are still close to the full age pension zone, they may also receive about $45,386 a year from the pension. That gives them a total income of about $69,000 a year.

Now compare that with a couple who have $1 million in assets. They might have about $970,000 invested and the same $30,000 in other assets. Drawing 5 per cent gives them $48,500 a year from super.

But their age pension drops sharply, to about $6600 a year. So their total income is closer to $55,000 a year. In other words, they have nearly half a million dollars more in savings but at that same drawdown rate they end up with less income. That is the sweet spot in action.

You see the same pattern for singles.

A single home owner with about $342,000 in total assets might have about $312,000 in super and $30,000 in other assets. Drawing 5 per cent gives them about $15,600 a year, and they may still receive about $29,600 from the age pension. That’s roughly $45,000 a year in total income.

Compare that with someone with $700,000 in assets. They might draw about $33,500 from super but their pension falls to about $1700, leaving them with closer to $35,000 a year. Again, they have more capital but earn less income from the combination of the age pension and super at the same drawdown rates.

But they’re not worse off. Someone with more super can choose to draw more from it each year to lift their income. And, as their super balance reduces over time, their age pension can increase again because they move back into the thresholds. Please remember that.

For a single person who doesn’t own their home, the caps are higher because they’re allowed to hold more assets before the pension reduces. A single non-home owner with about $663,000 in assets might have about $613,000 in super and $50,000 in other assets.

At a 5 per cent drawdown rate, that produces about $30,650 a year from super, plus about $24,700 from the pension. That’s about $55,000 in total income a year.

But someone with $900,000 in assets, drawing the same 5 per cent, might receive about $42,500 from super and only about $6200 in pension, for a total closer to $49,000. So, again, more savings but not necessarily more income from the same superannuation drawdown rate.

This doesn’t mean you should aim to have less going into retirement. It means people with moderate balances should stop assuming they’re heading for a second-rate retirement just because they don’t have a seven-figure super balance.

The real lesson in this is that retirement income in Australia is layered. The amount you have in super matters. The amount you’ll qualify for from the age pension matters, too.

Work can make a difference to what you earn as well. And when those pieces are working together, the total retirement income someone with a lower or moderate super balance can achieve can be far better than people expect.

Too many Australians in pre-retirement think the age pension is something to be embarrassed about accessing, or that it only exists for people with almost nothing. That’s simply not true.

The age pension is a core part of the retirement system, and for many retirees it works beautifully alongside super. And many use it as their base layer and most reliable source of income, topping it up with their super balance and income from work.

In fact, about two-thirds of Australians of pension age rely on either a full or part age pension as part of their income once they reach 67 if they’re eligible.

Once you understand that, you might stop focusing on building the biggest possible balance and start focusing on how the retirement system actually works, so you can build the most effective layers of income and adapt as the rules change over time. Those are not always the same thing.

Bec Wilson is author of the bestseller How to Have an Epic Retirement and the newly released Prime Time: 27 Lessons for the New Midlife. She writes a weekly newsletter at epicretirement.net and hosts the Prime Time podcast.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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