I’m confused. What do all the superannuation terms mean?

I’m a wee bit confused by some terminology, and would love a simple-to-understand explanation. What is the transfer balance cap? What is the difference between accumulation and pension? What is meant by transition to retirement as it pertains to super?

Great questions. I’m sure you’re not alone in being puzzled by some of this terminology.

The transfer balance cap is the maximum amount of superannuation savings that can be put into a tax-free pension. Super exists to provide us with income when we retire. While we are working and contributing to our superannuation savings, they are in the accumulation phase. When we retire and need to start drawing money out of our superannuation, we convert it into the pension phase.

At this point of conversion from accumulation to pension, an assessment is made against your transfer balance cap. The current transfer balance cap limit is $2,000,000. If your super balance is below this level, you can transition all your accumulation balance into the pension phase. If your superannuation balance exceeds this $2,000,000 threshold, then you will need to leave the excess portion behind in the accumulation account.

Once in the pension phase, there is no tax on your drawings, or the investment earnings. Each year, you must withdraw a minimum amount, calculated as a percentage of your account balance based on your age. There is no maximum amount that can be drawn, so you have a very high level of flexibility.

While the pension phase is a 0 per cent tax environment, the accumulation phase is a low, or concessionally taxed environment. Earnings in the accumulation phase are taxed at 15 per cent.

Transition to retirement is a special provision within superannuation whereby you can simultaneously draw some income from your superannuation, while also continuing to work and earn employment income. As the name suggests, it is intended as a way to enable you to ease into retirement, rather than quit cold turkey.

We sold a property a few years back and are progressively feeding the proceeds into super as contribution caps allow. We recently contributed the maximum, and so it’s three years until we can go again. We have been keeping the sale proceeds in a term deposit. Should we continue with term deposits despite the falling rates, or should we move the money into something else for the next three years?

Primarily, this is a question about risk and reward. Term deposits are extremely secure. If you switch, you are aiming to take on more risk, with the expectation that you will be rewarded for that higher risk via increased returns. But of course, there’s no free lunch.

Ordinarily, the best way to manage risk is through an extended timeframe. The longer you invest, the greater your ability to absorb any periods where investment markets fall. You have a three-year investment period, which would not be considered long enough to invest in funds that are entirely share focused. There may, however, be some balanced-type funds that are suitable as a three-year investment. If you hunt around, most funds will have a recommended minimum timeframe to guide you.

It’s worth noting that rates have come down in line with inflation. If you were getting 5.5 per cent interest but inflation was 4 per cent, then your real return was 1.5 per cent. Today, term deposit rates are around 4 per cent, while inflation is at 2.1per cent, so your real return is 1.9 per cent, better than what you were getting a year or two back.

Paul Benson is a certified financial planner at Guidance Financial Services. He hosts the Financial Autonomy podcast. Questions to: paul@financialautonomy.com.au

• 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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