Account-Based Pensions Explained

Part 2 of our retirement income series

In our first article, we covered the three broad paths for your super at retirement — an Account-Based Pension (ABP), an annuity or IRIS product, or withdrawing altogether. The ABP is the one most retirees use, at least for part of their balance, so it's worth understanding properly: how it works, what actually controls your income, and the one structural piece — cash bucketing — that we see missing almost every time a retiree walks in with an industry fund pension already set up.

What an ABP Actually Is

An Account-Based Pension is simply your super balance moved from accumulation into the retirement phase, still invested, still in your name, but now paying you a regular income instead of sitting untouched. Two things change the moment that happens. First, investment earnings become tax-free (rather than taxed at up to 15%). Second, your pension payments become tax-free once you're 60 or over. You keep choosing how the money is invested; growth, balanced, conservative, or a mix, and you can generally adjust your payments or take lump sums whenever you like, subject to the fund's rules.

There's a limit on how much you can move into this tax-free retirement phase across your lifetime, called the Transfer Balance Cap; currently $2.1 million. Anything above your available cap space has to stay in accumulation (still concessionally taxed at 15% on earnings, just not tax-free) or be dealt with another way. If you're anywhere near this threshold, it's worth a proper conversation before you commute your balance across.

The One Rule You Can't Choose Around: Minimum Drawdowns

The government sets a minimum percentage of your balance you must draw out each year, based on your age at 1 July. There's no maximum (unless you're a transition-to-retirement pension that hasn't met a full condition of release), so you can always take more, just not less.

These minimums are recalculated on your balance each 1 July, which means your dollar income can move around from year to year even if you don't change a thing, another reason the underlying investment strategy matters more than it first appears to.

The Trade-Off Nobody Mentions: Sequencing Risk

An ABP's flexibility comes at a cost: your income is directly exposed to how markets perform, every single year you're drawing from it. That wouldn't matter much if markets moved in a smooth, predictable line. They don't — and a fall in the first few years of retirement does more damage than the same fall ten years in, because you're forced to sell more units, at lower prices, to generate the same dollar income. This is sequencing risk, and it's the single biggest argument for having a deliberate income structure rather than one lump balance sitting in a single diversified option.

The Deep Dive: Cash Bucketing

Cash bucketing is the adviser staple for managing sequencing risk, and it's simple in concept: instead of holding your whole ABP balance in one investment option, you split it into buckets with different jobs and different time horizons.

The mechanics: Bucket 1 funds your actual pension payments, so it's never sold down in a falling market. When markets are performing well, you top Bucket 1 back up from Bucket 2 or 3, effectively selling growth assets into strength rather than into a downturn. When markets fall, you simply draw down Bucket 1 further and leave Buckets 2 and 3 alone to recover. The result is that your income keeps flowing on schedule, and the growth portion of your portfolio isn't forced to crystallise a loss at the worst possible moment.

Why we almost never see this in industry fund pensions

Here's the pattern we see constantly with retirees who come to us with an existing account-based pension through an industry fund: there's no bucket structure at all. The whole balance sits in a single ‘balanced’ or ‘growth’ option, pension payments are drawn proportionately across that one option, and the member has full exposure to sequencing risk without realising it. It's not that industry funds are doing anything wrong, most simply aren't built to construct and actively manage a multi-bucket strategy for an individual member, and the member was never shown the alternative. Cash bucketing isn't a product you buy; it's a structure someone has to actively build, implement, and rebalance over time; which is exactly the kind of thing that tends to fall through the cracks without advice.

Setting It Up in Practice

- Most retail super and pension platforms let you split your balance across multiple underlying investment options within the one account, this is usually how a bucket structure is actually implemented, rather than opening separate accounts.

- Bucket 1 is typically sized around 12-24 months of pension payments, adjusted for your other cash reserves outside super.

- The split between Buckets 2 and 3 depends on your overall risk profile, age, and how much of your income needs are covered by other sources (Age Pension, annuity income, rental income, and so on).

- It needs revisiting at least annually, buckets that are never refilled or rebalanced quietly turn back into one big undifferentiated balance over a few years.

Where to start

If your account-based pension is sitting in a single investment option with no cash buffer, that's worth a look regardless of how the last few years of markets have gone, the risk is in the years you haven't had yet, not the years just past. Get in touch with the Funded Futures team and we'll review your current structure.

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