Retirement income stream options: How account-based pensions compare

If you’re looking for somewhere to invest your nest egg, you won’t have to look far. There are literally thousands of financial products out there, many of them aimed squarely at 60-pluses and the billions of dollars in retirement savings they’ve amassed.

That’s because retirees’ desire to create an income from their savings is well known – and logical. After all, Australia’s retirement income system is built on the premise that you will do your best to put aside money during your working life, on which you’ll then draw to meet your expenses in retirement, possibly supplemented by the Age Pension.

Many experts say that the simplest and most obvious place to put your retirement savings – a superannuation fund – is also the best choice of this plethora of products, because it offers tax advantages, transparency, security and income-creation possibilities few standalone products can match.

To examine whether that’s the case, we’re going to run you through some of the pros and cons of different investment types. But first, here’s a quick refresher on the basics of investing money.

In short, high return tends to equal high risk.

It’s an old saying but it’s absolutely true when you think about the detail. Any investment promising a high return carries risk. You might have seen advertisements offering “a regular, secure return of 15 percent”. Many such investment propositions wouldn’t really be considered secure at all by most investment professionals. You may be unperturbed by that but it’s important that you’re aware of it, so you can determine whether you’re comfortable with the level of risk involved.

That said, high-risk investments aren’t necessarily bad. Shares and property are classed by some as high risk yet are among the favourite choices of many investors. But it does mean they aren’t as safe as cash or a fixed interest investment and because that’s the case, investors expect to be paid a higher return over the long term as a result.

Understand diversification

Diversification just means ‘don’t put all your eggs in one basket’.  Spreading your money across a number of different investments is safer than holding all of your money in just one.

Taking that a step further, holding a number of investments across a number of different asset classes – cash, fixed interest, shares and property – can add another layer of protection. That’s because if one asset class performs badly (let’s say shares have a bad year), chances are another asset class (such as property) will often be doing better.

The more secure options

When talking about ‘secure’ investment options, most experts are referring to savings or term deposits and longer-term fixed income investments such as annuities.

But while it’s important to have some cash on hand to meet your day-to-day expenses and the unexpected one-offs, your bank account isn’t ideal for generating retirement income.

Even though the Australian Government guarantees bank deposits up to the value of $250,000, making a deposit account a secure investment, you’ll only get a very low rate of return. Over time, the buying power of your money could actually fall thanks to inflation.

Term deposits and annuities are also highly secure, but with interest rates at record lows, they won’t generate much income unless you have a significant sum to invest.

There’s also little protection against inflation (unless, when it comes to annuities, you specifically purchase an option that protects you against it) and there’s not much flexibility because accessing your funds before the investment matures usually means you’ll lose some of your promised return.

The growth options

Investing in real estate has become an Australian obsession and many people have become wealthy through property. But house prices don’t always rise; they can fall sharply, as they are now in some areas, which can quickly wipe out your investment if you’ve borrowed money.

There’s another issue retirees need to consider, and that’s diversification. If you invest in a single rental property to give you income, all of your eggs are in one basket. That can be a problem if prices fall, you struggle to find good tenants or you need access to a large chunk of your savings quickly.

Shares and property, are popular with retirees and can provide a regular income with growth potential. Unlike buying a single investment property, you can spread your risk by buying from a number of companies across different sectors, such as mining, banking and healthcare.

The downside? You’re responsible for picking the shares (sometimes that’s best left to the experts and you can, of course, consult a financial advisor before doing so) and you’ll need to look after the paperwork for buying and selling your stock and receiving dividend payments. These sales usually require you to pay a broker’s fees, plus, if you sell shares at a profit, you could cop a substantial capital gains tax bill.

A bit of everything

Many seasoned investors with considerable sums to invest build their own diversified portfolios of high- and low-risk assets. But if you have a small-to-medium-sized savings pot, your money may be sufficient to purchase exposure to a wide enough variety of assets to be properly diversified. Or you may not feel confident about making specific investment choices yourself.

In these cases, using super to create your retirement income can provide the advantages of selecting individual investment assets, while avoiding some of the common pitfalls, Gemma Pinnell, director of strategic engagement at Industry Super Australia, says.

“All Industry SuperFunds give you access to a wide range of investment classes, including property, shares, cash and fixed interest,” she says.

“So, you’ve got the safety of very broad diversification, plus you benefit from expert management of your money, at a low cost.”

[Link to A simple step-by-step guide to switching superannuation funds]

Pinnell further points out that drawing an account-based pension from your super allows you to receive regular income, unlike, for example, share dividends, which are usually only paid once or twice each year.

“Industry SuperFunds let you choose how often you’d like to receive a payment, and your money’s not locked away for a fixed term – you can make lump sum withdrawals at any time,” she adds.

The tax advantage

Another benefit of using super for your retirement income is tax; with account-based pensions, there isn’t any!

Pinnell explains that fund earnings, including capital gains, aren’t subject to tax, and income paid from your fund is also tax-free. “If the fund sells assets such as shares or property and makes a capital gain, then there’s no tax payable by the fund or the investor,” she says.

That contrasts to holding shares in your own name, where you could face a capital gains tax bill when you make a profit.

“That convenience doesn’t come at a cost either, because Industry SuperFunds consistently provide highly competitive returns, historically above those available from bank-owned retail super funds,” Pinnell says.

Super also offers the ability to create a retirement income even from a small super balance, with some super funds able to do so from as little as $10,000. That sum wouldn’t get you far if, by contrast, you were looking to a residential investment property to supply a retirement income stream.

As with all other investments, it’s important to remember, though, that your superannuation fund’s performance can change from year to year and that historical performance isn’t a reliable predictor of future performance.

If you’d like to explore what income super can provide you and need guidance on selecting the best fund option, your Industry SuperFund offers access to expert advisors who can talk you through the most promising fund for your purposes.

How do you feel super stacks up against other retirement income-producing options? What asset class or investment option has worked most effectively for you?