Longevity Risk and Deferred superannuation income streams

The main attraction of deferred superannuation income streams is that they can manage longevity risk – that is the risk that the superannuation capital supporting an account-based pension may run out during the member’s lifetime.  Deferred superannuation income streams manage this risk as they are guaranteed to be payable for the life of the member (the guarantee is provided by the life company issuing the product) and because the income stream has the benefit of the earnings tax exemption during the deferral period and is not subject to the minimum payment requirement during the deferral period.

For the deferred superannuation income stream to enjoy the earning tax exemption (as if it were in pension phase) the member receiving the pension must either have attained age 65, be retired for superannuation purposes or be permanently incapacitated.  Once the deferral period has ended, then the income stream will be subject to the minimum pension payment rules.

Example of account-based and deferred superannuation income streams.

John has just attained age 65 on 1 July 2018.  He has a super balance of $900,000 and wishes to commence a retirement income stream.  John has a number of options as to his retirement income streams.  The first option is to commence an account-based pension using the entire pension balance.  The second option for John is that he could also commence a retirement income steam with only $600,000 leaving $300,000 remaining in accumulation phase.  A third option for John is to commence an account-based pension for $600,000 and with the balance of $300,000 purchase a deferred superannuation income stream with a 20 year deferral.

The first option – being an account-based income stream with the entire $900,000 – will provide pension payments for 2018/19 of a minimum of $45,000 (that is 5% of the initial pension balance of $900,000).  The entire $900,000 will be on the sunny side of the super fund as the balance will be entitled to the earnings tax exemption.  Also, the transfer balance account of John will be credited with $900,000: consequently, he will have exhausted about 56% of his $1.6m transfer balance cap.

The second option – being an account-based income stream with $600,000 and leaving $300,000 in accumulation phase – will provide pension payments for 2018/19 of a minimum of $30,000 (that is 5% of the initial pension balance of $600,000).  The $600,000 will be entitled to the earnings tax exemption.  However, the $300,000 will not be on the sunny side of the super fund as its earnings will be subject to 15% earnings tax.  But, the $300,000 is not being reduced by mandatory benefit payments.  The second option means that John will have his transfer balance account credited with only $600,000: consequently, he will have exhausted about 38% of his $1.6m transfer balance cap.  As the $300,000 is not on the sunny side of the fund, there is no credit made to the transfer balance account in respect of that amount.

The third option – being an account-based income stream with $600,000 and investing the balance of $300,000 in a deferred superannuation income stream – will provide pension payments for 2018/19 of a minimum of $30,000.   Like the second option, the $600,000 is on the sunny side of the super fund.  So as in the second option, John’s transfer balance account will be credited with $600,000.  But, unlike the second option, the $300,000 is also on the sunny side of the super fund and a separate $300,000 credit will be made to his $1.6m transfer balance account.   Once the deferral period has ended on 1 July 2038, pension payments will then commence and they will be payable for the duration of John’s life.  The pension payments will be determined by the terms of the deferred superannuation income steam (and not subject to the method of determining the minimum pension payments which applies to account-based pensions).  Additionally, the increase in value of the deferred superannuation income stream from $300,000 is not counted for the purposes of the transfer balance cap.