Super or savings: which should you spend first in retirement?

Once people have worked out how much they can draw each year, a second question arrives almost immediately and gets far less attention: which pot does it come out of? Super, or the money outside it? Most people default to whichever account is easiest to access, and that default can quietly cost tens of thousands of dollars over a retirement — in tax paid, in Age Pension forgone, and in what eventually reaches their children.

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Why does it matter which account you draw from first?

Because the Australian system doesn’t tax money. It taxes money in a particular place.

Move $50,000 from a super pension into your bank account after 60 and, from a taxed fund, you generally pay nothing. Sell $50,000 of shares held in your own name and you may have a capital gain to declare. Leave the same $50,000 inside super and its future earnings are untaxed in the pension phase, taxed at 15% in accumulation, or taxed at your marginal rate outside super altogether.

The asset hasn’t changed. Only its address has. And over a 25-year retirement, addresses compound.

There’s a second reason the order matters, and it’s the one people find more uncomfortable: the money you spend last is the money your children inherit. Some of it arrives with a tax bill attached and some doesn’t. Deciding which pot to preserve is, unavoidably, an estate decision as well as an income decision.

The four places your money can sit

Most retirees have money in some combination of four places. Here is how the same asset — say a diversified share portfolio — behaves in each, for someone over 60.

Read down the last two columns and the point lands. Two households with identical net worth can receive very different Age Pension payments, and leave very different amounts to their children, purely because of where the money is parked.

That’s also why the transfer balance cap exists. It’s currently $2.1 million, and it limits how much you can move into that top row. The government caps it precisely because the top row is so much better than the others. Your own cap may differ from the general cap if you’ve already started a retirement-phase pension — the ATO explains how in Calculating your personal transfer balance cap, and you can check yours in myGov.

The tax you already owe but haven’t paid

Two liabilities sit inside people’s balance sheets without appearing on any statement.

Unrealised capital gains

A parcel of shares worth $400,000 that you bought for $120,000 is not $400,000 of spendable money. There’s an unrealised gain of $280,000 sitting inside it, and when it’s sold, a portion belongs to the Australian Taxation Office.

Here’s the part people don’t expect: dying doesn’t clear it. Post-CGT assets generally pass to beneficiaries at your original cost base — the ATO sets this out in Cost base of inherited assets. The liability transfers to your children along with the shares. It isn’t wiped, it’s inherited.

The taxable component of your super

Almost every super balance is split into a taxable component and a tax-free component. Most people have never looked at the split, and most statements don’t make it obvious.

It matters enormously at one moment. Paid to a spouse, or to anyone who was financially dependent on you, the whole benefit is tax-free. Paid to an independent adult child, the taxable component is taxed at up to 17%. On a $600,000 balance that’s entirely taxable component, that’s a six-figure difference in what your children actually receive. The ATO sets out who counts as a dependant and how each component is taxed in Superannuation death benefits.

Why this belongs in a drawdown conversation. Both liabilities can be managed — the first by choosing when gains are realised and in whose hands, the second through strategies such as recontribution, which converts taxable component into tax-free component. But both are time-limited. Recontribution generally requires you to be under 75 and within the non-concessional contribution cap, which the ATO publishes at Non-concessional contributions cap and we cover in this year’s contribution caps. The window opens around 60 and closes at 75, which is exactly why this is a conversation for your early sixties, not your late seventies.

The case for drawing super first

Drawing from your account-based pension first is the most common approach, and for many people it’s right.

It’s tax-free and simple. From 60, payments from a taxed fund generally arrive without a tax consequence and without a tax return complication (ATO, Retirement withdrawal — lump sum or income stream).

You have to draw something anyway. Minimum drawdown rules mean a percentage must come out each year regardless — 4% under 65, 5% from 65 to 74, rising with age (Moneysmart, Account-based pensions). If you’re taking it out, you may as well spend it before touching anything else.

It reduces the future death benefits tax. Every dollar of taxable component you spend is a dollar that can’t be taxed at 17% in your children’s hands.

It keeps your outside money available. Money in your own name is the most flexible money you have. Preserving it preserves your ability to respond to a health event, an aged care bond, or a child who needs help.

The trade-off is that you’re running down the only environment where earnings are completely untaxed. Once money leaves the pension, getting it back in is limited by the contribution caps and by age.

The case for drawing savings first

The opposite approach suits a smaller group, but suits them well.

You can realise gains cheaply. A retiree with little other assessable income may be able to sell down a portfolio and realise capital gains at very low marginal rates — sometimes close to nil, helped by the 50% discount on assets held over 12 months (ATO, How to calculate your CGT). That’s a chance to shrink an embedded liability at a discount, and it disappears once other income rises.

It preserves the tax-free environment. Leaving more inside the pension means more of your money compounds without tax drag.

It can improve your Age Pension position. Spending down assessable assets outside super, or redirecting them into an exempt asset such as your home, may increase your entitlement — see the next section.

It simplifies the estate. Fewer personally held assets with embedded gains means less complexity for your executor.

The trade-off is liquidity. Spend your outside money first and you may have nothing readily available when something unexpected happens, because super has rules attached even when you’re eligible to access it.

Five questions that actually decide it

In practice, most households don’t pick one pot. They draw from both in deliberate proportions. The best order to withdraw your retirement savings — and in what mix — comes down to these five.

Where the Age Pension changes the answer

The means tests apply what amounts to a tax on your capital that has nothing to do with what that capital earns.

Under the assets test, every $1,000 of assessable assets above the threshold reduces your pension by $3 a fortnight. That’s $78 a year per $1,000 — an effective rate of 7.8%. No conservative portfolio reliably earns 7.8%. For a household sitting in the taper zone, a dollar of assessable assets is genuinely worth less than a dollar that isn’t assessed.

This produces results that feel counterintuitive until you see the mechanism:

• A younger spouse’s super can shelter money. Super in accumulation phase is generally exempt from both tests until that member reaches Age Pension age. For couples with an age gap, this is one of the largest levers available.
• Money spent on the family home leaves the assets test entirely. Renovating is not the same as investing, but it is treated very differently — which is part of the picture when people consider a downsizer contribution.
• Drawing order changes the timing of when assets are counted, and therefore when entitlement starts.

None of these are loopholes. They’re the deliberate architecture of the system. Thresholds are indexed each March and September, so check the current figures with Services Australia rather than relying on last year’s numbers. If your payment has moved without your balances changing, the deeming rules are usually behind it.

Does living in Melbourne change the answer?

Not the rules. Superannuation and capital gains tax are administered federally by the Australian Taxation Office, and the Age Pension by Services Australia. They work identically in Bundoora, Bendigo and Broome. There is no Victorian variation and no Melbourne-specific drawdown strategy.

What changes the answer is your own position — how much of your wealth sits in the family home versus in accounts that can pay you an income, the size of any capital gain outside super, whether you’re in the Age Pension taper zone, and who your beneficiaries are. Two households in the same street can arrive at completely different drawdown orders.

That’s the useful thing to take from this: the order isn’t determined by where you live, and it isn’t determined by a rule of thumb. It’s determined by the five questions above, applied to your actual numbers.

What happens on death — the part most people miss

The taxable/tax-free split is one of the least examined numbers in most people’s finances, and one of the largest in dollar terms.

Two identical balances, two very different outcomes

Two people each die with $600,000 in super, leaving it to an independent adult child. The first balance is entirely taxable component; the second has been managed over several years so that most of it is tax-free component. The first child receives materially less than the second — on the same starting balance, from the same fund, invested the same way.

Nothing about the investment differed. Only the composition did.

Three things follow from that.

• Check your split. Your fund can tell you. It should be on your statement or available through your online account. If you don’t know your split, you can’t plan around it.
• Check your nomination. A binding death benefit nomination directs where the money goes, and many lapse after three years without the member realising. A valid nomination and a tax-efficient composition are two different things, and you need both. The ATO’s guidance for beneficiaries of a deceased estate sets out what the person receiving the money will face.
• Understand that spending is a strategy. If your children are your beneficiaries, spending taxable component during your lifetime is one of the simplest ways to reduce what’s taxed later. That reframes drawdown from “using up my money” to “using the right money.”

If your balance is large enough that Division 296 is in play, these decisions interact and are worth modelling together rather than one at a time.

Where this usually goes wrong

Most people’s financial position is assembled rather than designed. Each piece made sense when it was acquired — a super fund from an old job, shares bought years ago, a term deposit, and often a second super account nobody ever got around to consolidating. What’s often missing is any point at which someone asked whether the pieces work together.

When drawdown begins, that shows up. Money comes out of whichever account has the simplest transfer, and after a few years the composition of the wealth has shifted in a direction nobody chose.

Two situations are particularly hard to fix once reached. The first is arriving in your late seventies with a super balance that is almost entirely taxable component and adult children as the intended beneficiaries — by then the window for recontribution has closed. The second is spending years optimising investment returns while never examining which account the income should come from, so the gains are partly given back in tax and forgone Age Pension.

Neither is an investment problem. Both are drawdown order problems, and both are addressable years before they become visible — which is why mapping the whole position before you start drawing tends to be worth more than any single decision made along the way.

Common mistakes

Summary

How much you draw determines whether your money lasts. Which pot you draw it from determines how much of it you keep, how much Age Pension you receive along the way, and how much reaches the people you leave it to.

There is no single retirement drawdown order that’s right for every Australian household. There is a right one for yours, and it depends on your means-testing position, the embedded gains outside super, the composition of your super, who your beneficiaries are, and how much flexibility you need to hold in reserve.

What’s not optional is making it a decision rather than a default.

Frequently asked questions

Next steps

If you’ve built the assets but nobody has ever mapped which account your retirement income should come from — and what that choice does to your Age Pension and your estate — that’s exactly the work we do. You can read how we approach this at Plan My Wealth, or book a conversation and we’ll look at it together.