Protecting an account-based pension in its first five years

In March 2020, with the ASX 200 down more than a third from its February peak, the federal government halved the minimum drawdown rates for account-based pensions. It had done the same during the global financial crisis, and for the same reason: retirees were selling shares at depressed prices to fund a withdrawal the law would not let them skip.

Both times, relief came after the falls. Nothing guarantees it next time. The temporary halving ended on 30 June 2023 and full rates have applied since. If you are starting a pension now, assume the minimum will be enforced in full through the next downturn.

What you can manage is the order in which returns arrive. Most of that risk sits in the first few years.

Why the first five years carry most of the risk

Two retirees can earn the same average return over 20 years and finish with very different balances, purely because one met the bad years first. A loss costs most when the balance is at its peak and withdrawals have already started. For most people that means the five years after super converts to a pension.

Take a 67-year-old with $500,000 in a balanced option. They plan to draw $35,000 a year, above the 5% minimum of $25,000. Say growth assets fall 25% and the whole $35,000 has to come from selling units. Those units were worth $46,667 before the fall. Once sold, they take no part in the recovery. A second bad year compounds it.

At 85 the same withdrawal matters less. The balance is smaller and fewer years remain to be funded.

Schedule 7 of the Superannuation Industry (Supervision) Regulations sets the minimums:

Age at 1 July	Minimum annual payment
Under 65	4%
65–74	5%
75–79	6%
80–84	7%
85–89	9%
90–94	11%
95 and over	14%

Treasury's Retirement Income Review, released in 2020, found that many retirees draw at or near these rates and die with much of their super unspent. For them the minimum is the whole withdrawal, and it still can't be skipped in a bad year. It is calculated on the 1 July balance (pro-rated in the year the pension starts), so it shrinks after a crash. It never reaches zero.

Building the cash buffer inside the pension

The usual answer is to keep part of the pension in a cash or term deposit option and pay withdrawals from that. Growth assets sit untouched while prices are down.

The fund has to be told, though. Most large funds let members nominate which investment option pension payments come from. Without a nomination, payments are usually drawn proportionally across every option held, which means growth assets get sold in a falling market anyway.

Run the same 67-year-old through it with two years of planned spending set aside: $70,000 in cash and $430,000 in growth. A 25% fall takes the growth portion to $322,500 and the total balance to $392,500. Next year's minimum, at 5%, is $19,625. The cash pays the planned $35,000 for two full years, and not one growth unit is sold at the low.

Cash costs something. If the cash option earns three percentage points less than balanced, $70,000 gives up about $2,100 in an ordinary year, and over a decade that is real money. I think it is worth paying in the first five years, because it means you are never a forced seller. At 85, with a smaller balance and a higher minimum rate, I'm less sure.

How big should the buffer be? That depends on the fall it has to cover. One year of spending would have got a retiree through 2020, when the market regained its losses a little over a year after the March low. The GFC took far longer. The ASX 200 price index did not pass its November 2007 high until 2019, though reinvested dividends cut the wait considerably for anyone in a total-return fund. Three years of spending covers more scenarios and costs roughly three times as much.

Write the refill rule down before you need it. A common one tops up cash from growth assets after a year when the growth option returned above a set level, and lets the cash run down after a negative year. Decided in the middle of a fall, these calls tend to go badly.

When a financial adviser helps

Two things the example leaves out change the answer for most retirees. One is the Age Pension. A part-pensioner gets a payment that doesn't drop when markets do, so less of each year's spending has to come out of the account-based pension. Under the assets test, a smaller pension balance can also lift the Age Pension entitlement, which offsets part of the loss.

The other is money held outside super, such as an offset account or term deposits in a personal name. That money can be the buffer instead. Its tax and means-test treatment differ.

Fitting those pieces to one household means looking at the Centrelink position and the money outside super together. Retirees who want the buffer size and drawdown order checked against their own pension can take it to the financial advisors at Solace Financial.

Plenty of people won't need to pay for that. With a modest balance and a simple plan, you can set the drawdown nomination yourself through the fund's online portal. A fee makes more sense where the pieces interact: a couple running two pensions at different ages, say, or a balance close to the transfer balance cap, currently $2 million.

The figures above are illustrations. They take no account of anyone's tax position or other income.