How superannuation works

Key points

  • Australia's retirement income system comprises three pillars: the age pension, superannuation savings and supplementary voluntary savings.
  • You can contribute a maximum of $25,000 each year into your superannuation account pre-tax. You can contribute another $100,000 after-tax.
  • When you contribute to superannuation this money is added to your accounts and the investment choices you have already selected.
  • When you retire you can access your superannuation entitlements as either an income stream or a lump sum.
  • Your superannuation retirement benefits are tax-free unless you have accumulated more than $1.6 million. Only the component above this threshold is taxable. 

To help Australians to retire with some degree of financial security, successive Australian governments have developed our retirement income system. It is a combination of your age pension, your superannuation savings, and extra savings supplemented by special benefits for lower income earners.

Three pillars of the Australian retirement system

These core elements comprise what is known as the three pillars of Australia's retirement income system.

Pillar 1: A means-tested and publicly-funded age pension

If you are older than 65 years of age, have retired, and satisfy the age pension income and assets test you could receive an annual age pension of up $22,000 per year if you are single or up to $33,100 per year for a couple. By 2023 the age at which you may qualify to receive the age pension will have progressively increased to 67 years.

Pillar 2: Superannuation savings

To encourage you to supplement your age pension, Australians can set up a superannuation account, which is a long-term savings account dedicated to holding your retirement savings. Employees are required to contribute (deposit) at least 9.5% of their salary into their superannuation account, though usually their employer does this on their behalf (via the superannuation guarantee). You are also allowed to contribute extra money to your account and can choose to set up other accounts instead of the one chosen by your employer.

The good news is these superannuation contributions and your account's investment earnings are taxed concessionally at a nominal 15% rather than at your regular marginal income tax rates. There are generous limits regarding how much you can contribute or receive as tax-free retirement benefits.

Pillar 3: Voluntary extra savings

You can boost your retirement savings by taking advantage of other concessional taxation arrangements, such as negative gearing, capital gains tax concessions or franking credits. Low-income earners are directly subsidised to make extra personal superannuation contributions.

While many people still qualify for the age pension, as superannuation savings grow and become more important for more Australians, more are qualifying only for the part-rate age pension.

The superannuation component of Australia's retirement income system has four key aspects.

1. How you choose a super fund

Most people are first introduced to superannuation through their employer, who pays their compulsory contributions (currently equivalent to 9.5% of their annual salary) into their default superannuation fund unless an employee has nominated another fund. These compulsory contributions are known as the superannuation guarantee (SG).

Compulsory contributions can only be paid into complying MySuper products that have been authorised by the superannuation regulator, the Australian Prudential Regulation Authority (APRA). If you are eligible for super choice, i.e., you can choose your own super fund, your employer is not allowed to restrict your choice of fund. But it is not your employer's responsibility to make sure you are a member of that fund.

You can make extra voluntary contributions into your default MySuper fund or other funds of your choice. These funds might be industry funds, retail funds or self-managed super funds (SMSF). If you join a fund on your own without going through your employer, you are joining it as an individual personal member.

2. How you can contribute to superannuation

There are several ways to contribute to your superannuation accounts: contributions paid through your employer, personal contributions you make directly, or bonus contributions paid by the government.

Employer contributions

If you are an employee older than 18 years of age earning more than $450 per month, or under 18 years of age earning above $450 per month and working more than 30 hours per week, you should be receiving SG contributions equivalent to 9.5% of your base salary or wage. These compulsory employer contributions, which you pay on a pre-tax basis, i.e., before your income tax has been deducted, must be paid into a complying MySuper product, or another superannuation fund or product that you've chosen.

You can ask also your employer to deduct extra contributions from your salary. These contributions, known as salary sacrifice contributions, are also paid pre-tax.

Personal contributions

If you make additional superannuation contributions on top of your SG and other employer contributions these are known as personal contributions. These contributions are paid from your net salary, i.e., after your income tax has been deducted.

You may be entitled to claim a tax deduction for your personal contributions. If you earn less than $37,000 per year you may be entitled to a special government co-contribution of up to $500.

Age and concessional limits

You can contribute up to $25,000 per year on a pretax basis into superannuation regardless of your age and income. This limit includes all contributions paid through your employer or for which you intend to claim a tax deduction. If you contribute more than $25,000 you may have to pay a special tax levy. Contributions paid this way are known as concessional contributions because you received a tax concession in association with them.

If you have less than $1.6 million in superannuation, you can contribute up to $100,000 extra per year in additional non-concessional contributions. These are contributions for which you receive no tax concession or tax deduction. If you exceed this limit you have to pay a 47% taxation penalty on the amounts paid above $100,000. Note that this limit is indexed. If you have more than $1.6 million in superannuation you are not allowed to make extra contributions.

Spouse contributions and splitting

If your legally-recognised spouse earns less than $37,000 per year you may be able split your superannuation contributions and pay a portion of them into your spouse's superannuation account. By doing this you not only boost their superannuation, but you may be able to claim a tax offset, which is a direct reduction in income tax.

The maximum tax offset amount you can claim is $540, although it reduces gradually as your spouse's income exceeds $37,000 and completely phases out if they earn more than $40,000.

Insurance cover through your super fund

When you join a MySuper product or any other super fund you may have to buy a minimum level of insurance cover. This standard cover usually comprises death and TPD cover, although some funds also include income protection cover. The cost and amount of this cover varies depending on your super fund, but in 2020 it was found to average about $6 per week and cover you for an average $189,000. Almost all super funds allow you to buy extra insurance and customise your cover. If you are less than 25 years of age you may not have to purchase this standard cover.

3. How your super savings are invested

When you contribute to superannuation, the fund invests your money into the capital markets comprising shares, property, bonds, cash, infrastructure and other types of investments.

How your money is specifically invested will depend on which investment options you have selected. For example, if you are a member of a MySuper product, your money will be invested across a diversified portfolio spanning all major asset class types, although it will be weighted in favour of growth assets such as shares and property.

Similarly, if you have selected, say, investment options explicitly focused on Australian shares then your superannuation contributions will be used to invest only into Australian shares. Reflecting on this, you should carefully consider the investment choices offered by your fund because your super contributions will be linked to these investments.

4. How you can receive your benefits

Superannuation is a special-purpose savings scheme designed to support you in retirement. To access your superannuation and begin withdrawing some of your money from your accounts you need to be older than your preservation age and retired or approaching retirement or have been directly affected by the COVID-19 pandemic. While these complexities can seem confusing, there are nevertheless some core principles to follow:

  • you have turned age 65 (even if you haven't retired)
  • you have reached your preservation age and retired
  • you have reached your preservation age and even though you are still working you qualify to set up a transition to retirement pension
  • you have lost your job or suffered a large fall in your income due the COVID-19 pandemic.

There are other circumstances in which you may be able to get access to your superannuation, but these are very limited. For example, you have specific medical conditions, are terminally ill, or are facing severe financial hardship (e.g., due the impacts of COVID-19), and you have no other sources of money available. In these cases you may be able to apply to the ATO to make a formal request for early access to your superannuation.

There is also the First Home Super Saver Scheme designed to enable people to use their superannuation to help them save a deposit for their first home. When you have worked through these options and have decided to begin accessing your super there are two main ways to do this: set up a superannuation income stream or access some or all of your super entitlements as a lump sum.

What is your super preservation age?

Your preservation age is the minimum age at which you can access your superannuation. Your specific preservation age depends on when you were born. For example, if you were born before 1 July 1960 your preservation age is 55 years. It changes gradually for people born slightly later, up until it reaches 60 years for people born between July 1963 and June 1964. In practical terms, this means that for people who in 2020 are younger than 55 years of age, they won't be able to access their superannuation until they are at least aged 60.

Superannuation income streams

A superannuation income stream is a special superannuation retirement account that allows you to receive regular payments from your super account every week, month or annually. These income stream payments are sometimes referred to as superannuation pension payments or annuities.

These pay you a regular amount over a set period and meet the minimum annual payments for superannuation income streams-the purposes of these minimums being to ensure that retirees spend a reasonable portion of their retirement savings on themselves and so reduce their reliance on the age pension.

These accounts come in two main forms: account-based pension accounts or a non-account-based income stream accounts.

Account-based superannuation income stream accounts operate similarly to regular superannuation fund accounts in that they offer investment choices but are supplemented with withdrawal options. Non-account-based income stream accounts are annuities where you pay, say, $200,000 to your account provider and they agree to pay you a set amount each month until your death.

Once you start a pension or annuity, a minimum amount is required to be paid (drawndown) each year. The following table shows the minimum drawdown rates that apply in 2020/21 (the rates were reduced by the government in March 2020 in response to the COVID-19 pandemic).

For a pension or annuity, a minimum amount is required to be paid (drawn) each year. The following table shows the minimum drawdown rates that apply in 2020:

Minimum drawdowns applying in 2020/21

Age of beneficiary

annual percentage drawdown
Under 65 2.0%
64-74 2.5%
75-79 3.0%
80-84 3.5%
85-89 4.5%
90-94 5.5%
95 or older 7.0%

Superannuation lump sums

A superannuation lump sum retirement benefit is when you withdraw some or all of your superannuation entitlements in a single payment. You may also be able to withdraw your superannuation across several lump-sum payments.

But you need to be aware that if you withdraw your superannuation as a lump sum, this money will no longer be considered superannuation, so if you invest it any income it generates may not qualify for concessional tax treatment. That is, income it generates is unlikely to be tax-free.

Superannuation death benefits

If you are a retiree and you die leaving some money in your superannuation account, your super fund will pay the balance to your dependants. If you are still working, your super fund will payout your balance, including any insurance benefits, to your dependants.

To make this process easier many superannuation funds have set up what are known as binding death benefit nominations, which enable you to stipulate who should receive your superannuation benefits. If you have not made such a nomination, the trustee directors of your superannuation fund have to decide who should receive this money.

 Understanding the types of super fundsShould I see a financial adviser? 

Further Reading