Lump Sum or Income Stream: What Leaving Super Actually Costs

01 The tax on the way out is the same

From a taxed super fund, a member aged 60 or over pays no tax on either a lump sum or an income stream payment. This is the fact everybody knows, and it is true. It is also the reason the decision gets made badly, because it makes the two options look identical at the moment of choosing.

Below 60 they are not the same, and the difference is large. Between preservation age and 60, the taxable component of a lump sum is taxed at nil up to the low rate cap and at 15% plus Medicare above it, while an income stream payment is taxed at your marginal rate with a 15% offset. Anyone in that window is making a genuinely different calculation from the one described here.

The tax-free and taxable components travel with the money in fixed proportion. You cannot elect to withdraw only the tax-free part; every payment carries the same mix as the account it comes from, which is what makes the recontribution strategy worth understanding before you start drawing.

Source: ATO — Tax on super benefits

02 Where the two paths actually diverge

The divergence is in the earnings, not the withdrawal. Inside an account-based pension in retirement phase, investment earnings — interest, dividends, realised capital gains — are taxed at nil. The same portfolio in your own name is taxed at your marginal rate on income and, after the discount, on gains when you sell.

For someone with little other income the difference may be small in year one, because the tax-free threshold and the seniors and pensioners offset absorb a lot. It is not small in year fifteen, because the untaxed portfolio has been compounding on a larger base the whole time. The worked example below puts a number on that gap.

This is also the answer to the question of what to do with a lump sum you take and do not spend. Money withdrawn and left in a bank account has taken every disadvantage of the lump sum and none of the reasons for it: the earnings are now taxable, the balance is still deemed under the income test, and the money can only get back inside super by using a contribution cap you may need for something else.

The size of the gap depends on your marginal rate, and a retiree with no other income has a low one. Someone drawing $40,000 a year of tax-free pension payments and nothing else has a taxable income of zero, so the first band of investment earnings outside super is taxed at nothing. The comparison sharpens for anyone with rent, a defined benefit pension, part-time work or a partner whose income fills the low bands — which is to say, for most people with a balance large enough for the question to matter.

Source: ASIC Moneysmart — Account-based pensions

03

The two paths, side by side, for someone aged 60 or over

	Account-based pension	Lump sum
Tax on the payment	Nil	Nil
Tax on earnings afterwards	Nil, in retirement phase	Your marginal rate, every year
Are you forced to withdraw?	Yes — a minimum percentage rising with age	No
Counted against the transfer balance cap	Yes, on commencement	No
Age Pension income test	Balance is deemed	Deemed if held as a financial asset; not assessed if spent on an exempt asset
On death, to an adult child	Taxable component taxed at 15% plus Medicare	Already yours; taxed in your estate under ordinary rules

04 The minimum drawdown is not optional

An account-based pension requires a minimum withdrawal each financial year, set as a percentage of the balance and rising with age. The zero-tax environment therefore drains on a schedule regardless of whether you need the money, which is the honest limit on the strategy of leaving everything inside.

The percentages and the ages behind them are set out in the minimum drawdown reference. What matters for this decision is the direction: the older you are, the faster the shelter empties, so the advantage of the income stream is largest for someone starting it at 60 and smallest for someone starting at 80.

Drawing the minimum and reinvesting it outside super is a partial defeat rather than a workaround. The money is now in the taxed environment, and the only thing that was preserved is the remaining balance.

There is one legitimate way back, and it has a limit. A withdrawal recontributed as a non-concessional contribution returns to super and can be used to start a second income stream, which is the mechanism behind the recontribution strategy. It is bounded by the contribution caps, by the work test rules that apply from 67, and by the age at which contributions stop being accepted at all, so it thins out precisely as the minimum drawdown accelerates.

Source: ATO — Minimum annual payments for super income streams

05 The transfer balance cap sets the ceiling

Only so much can be moved into retirement phase. The general transfer balance cap is a lifetime limit measured when you start an income stream, and any balance above it has to stay in accumulation, where earnings are taxed at 15%.

That still beats a marginal rate above 15%, so for a large balance the sequence is usually: fill the transfer balance cap with an income stream, leave the excess in accumulation, and take a lump sum only for a purpose. The mechanics of the cap are in the transfer balance cap reference.

It is commonly assumed that a balance over the cap should be withdrawn to avoid the excess-transfer-balance tax. It is not — the tax applies to amounts moved into retirement phase above the cap, not to money left in accumulation, and withdrawing it moves the earnings from a 15% environment to a marginal-rate one.

Source: ATO — Transfer balance cap

06 What the Age Pension does to the comparison

Under the income test, an account-based pension balance is deemed, and so is a lump sum sitting in a bank account. On that test the two are the same, which surprises people who expect the lump sum to be treated more harshly.

The real asymmetry is what a lump sum can be spent on. Money that goes into your home, or into repairs to it, leaves the assets test entirely, because the principal residence is exempt. That is a legitimate and deliberate feature of the system rather than a loophole, and for a part-pensioner near the assets threshold it can be worth more than the earnings-tax difference.

It cuts the other way for someone who will never qualify. A self-funded retiree gets nothing from the exempt-asset route and keeps only the earnings-tax difference, which points them firmly back at the income stream.

The timing matters as much as the amount. Assets are assessed at the date they are held, so a lump sum taken in June and spent on the house in August is assessed as cash for the fortnights in between. Where the plan is to convert super into an exempt asset, the gap between withdrawal and spending is the part worth compressing.

Source: Services Australia — Income test for Age Pension

07 What I would actually do

Start an income stream with everything you cannot name a use for, and take a lump sum only against a specific purpose with a date on it. That ordering costs nothing if you are wrong, because a further lump sum can be taken from the pension account later; the reverse is not true, since money withdrawn cannot go back in without using a contribution cap.

Size the lump sum against the purpose rather than against a round number. The common version of this decision is someone taking $100,000 because it sounds like a sensible reserve, spending $30,000 of it over five years, and paying marginal-rate tax on the earnings of the other $70,000 the whole time.

If the purpose is debt, run it against the alternative first. Clearing a mortgage with super is a real strategy with a real answer, and it is worked through separately in the mortgage versus super comparison.

Source: ATO — Payments from super (rates and thresholds)