Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 184

Asset test changes create questionable advice

From 1 January 2017 the asset test taper rate for the aged pension will increase from $1.50 to $3.00 per fortnight for every $1,000 in assets held above the threshold. This has led to some rather dubious analysis and advice suggesting that clients may be better off getting rid of their assets to maximise their age pension entitlement.

The reasoning goes along the following lines:

  • if a retiree’s assets exceed the new threshold by $100,000, their age pension will be reduced by $300 per fortnight or by $7,800 per annum
  • so for a retiree to be better off, they need a return of at least 7.8% on the $100,000
  • if they can’t achieve a return of 7.8%+, then they are better off placing that $100,000 outside of the asset test. They can do this by spending it on renovating the family home, a holiday, pre-paying funeral expenses or gifting the money to children and grandchildren (within the permitted limits).

The ability to draw from capital

This analysis, and the advice flowing from it, is questionable as it ignores the impact on the retiree’s annual ‘income’ from drawing down their capital. The goal of a retirement income strategy should be to maximise the retiree’s sources of cashflow over time. This can be achieved by drawing down savings in combination with a part pension rather than exhausting savings to be eligible for the full pension.

We can compare two scenarios. The first scenario is where a retiree spends the $100,000 (such as on a house) to reduce their assets and be eligible for the full age pension. In the second scenario, they keep the $100,000 invested, drawing down $15,000 each year until the amount is exhausted. For simplicity, this example ignores any drawdown of assets held below the asset test threshold levels.

The following chart compares both scenarios. The first scenario (spending the $100,000 immediately) is shown by the straight black line on the chart. This is the full age pension for a couple of approximately $34,000 per annum (there may also be energy supplements which boost this amount). This is in current dollar terms so the amount does not change over time with inflation.

The second scenario (drawing down the $100,000 over time) is shown by the columns on the chart. The blue section of the column is the part pension that the retirees receive after the reductions for the asset test (note for couple home-owners the income test will only have a greater impact on the pension once assets above the threshold level fall below about $27,000). The red section of the column is the additional income the couple receive each year by drawing down $15,000 from their savings. Assuming an investment return of inflation + 4% per annum, the $100,000 capital not spent on the house provides an income stream of $15,000 per annum for seven years and in year eight the couple can draw down about $13,500.

Not spending on the family home provides higher income

Drawing down their $100,000 as an 'income' stream of $15,000 per annum will, in combination with a part pension, provide a materially higher annual income and standard of living compared with spending their $100,000 in year 1 to maximise their entitlement to the age pension. Of course, the family home has not benefitted from the $100,000 capital spent on it, but nobody knows how much that will improve its value (which may well go to the beneficiaries of the estate in any case).

The faulty reasoning involved in spending the $100,000 in year 1 is a classic example of mental accounting bias. This bias places a different value on a dollar of income and a dollar of accumulated capital in being able to support a retirees’ lifestyle. In this example the retirees have placed a greater value on the ability to access an additional $7,800 in aged pension in year 1, over the $15,000 in additional 'income' from drawing down their accumulated savings.

 

Gordon Thompson CFA is Senior Manager, Platforms, at Perpetual. This article is general information and does not consider the needs of any individual.

 

8 Comments
Dudley.
February 15, 2020

Alternatives to asset test tapering of age pension rate for age qualified are:
1. No pension for those with assets.
2. Same pension rate for all regardless of assets.

Under 1. most will aspire to be destitute.
Under 2. all will aspire to be wealthier.

I find 2. a better outlook.

With 12% super guarantee required to be paid in addition to minimum wage, over a lifetime all full time workers will be self funded by having too much wealth to qualify for age pension under current income and assets test regime.

Greg
February 16, 2020

Nice summary Dudley,

I too find option 2 has a better outlook.

Imaging how much noise/friction/waste would be removed from the system if there was no need to communicate the complexities, analyse the tradeoffs, make choices and manage choices involved with pension qualification criteria.

It would remove costs from the economy at multiple different levels (providers, analysts, advisers, recipients) and free up the time of many minds to concentrate on something more constructive and value creating than finagling the rules to maximise individual circumstances.

Mark Hayden
December 07, 2016

Well done Gordon, that explains how a retiree can benefit in income terms via drawing down some of their capital over time. That is a good visual.

Gary M
December 01, 2016

Agree, Trev, but your second point looks like one of Gordon's arguments - enjoy a lifestyle that your capital allows by drawing it down while you can, and you always have the age pension to fall back on later.

Big Trev
December 01, 2016

There are some assumptions/comparisons here that need exploring.
1) You are comparing what amounts to a risk free rate of return (the age pension) with a real rate of 4 percent. That must by definition, require an exposure to risky assets.
2) You assume that income needs need to increase over time uniformly. They don't. It might not suit your model, but people age and then die. There is a lot to be said for enjoying your money while you can.
3) You also assume that upgrading the family home is sunk cost. In fact, it could add value and equally, may defer or negate future aged care expenses which could be significant.

The real lesson here is that no one size fits all and general pronouncements about one strategy being superior to the other fails to take into account the real purpose of planning a retirement - the individual.

Jack
December 01, 2016

What Gordon says is true. But if you take your $100,000 and put it into your principal residence, you get a different outcome. You improve our age pension payments because you have few assessable assets because the family home is not included in the assets test, but you retain your assets for future use, to downsize, to pay for age care or as an inheritance for your beneficiaries. To do this, you embark on some serious renovations or upsize your house.
The new assets test creates incentives for people to not downsize (and release more assessable assets) and actually spend more on their family home than they probably need. In that sense it is short sighted.
This is as much about behavior as it is about accounting.

David Roberts
December 01, 2016

This has always been my logic. A $ is the same whether it is a dividend, distribution or capital gain. My SMSF is aimed 90% for capital growth picking stocks with low dividends but potentially high ROA, ROE and EPSG/yr. When I need to draw down a pension amount I take it by selling the worst performing stock in terms of capital growth or those that are actually losing money irrespective of their dividend payout. The yld on falling stocks goes up as the price goes down but they may become an ABS or Babcock and Brown and go to zero.

Ashley
December 01, 2016

I question the belief that the goal of a retirement income strategy should be to maximise the retiree’s income over time.

There are plenty of dangerous ways to maximise ‘ïncome”. Surely there more important goals – eg minimizing the likelihood of running of money + relying on the charity of others, losing control of decisions like healthcare, etc, etc – or even building up inter-generational wealth in tax-advantaged environment, etc.

 

Leave a Comment:


RELATED ARTICLES

10 little-known pension traps prove the value of advice

Is it better to rent or own a home under the age pension?

Survey responses on pension eligibility for wealthy homeowners

banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.