The biggest changes to the pension asset test in 10 years will occur in two months, on 1 January 2017.
Whenever the government makes such drastic changes it creates winners and losers, while some that stay the same will worry about the changes nonetheless. If you’re a pensioner the important thing is to know which bucket you fall into and make a plan for how best to deal with it. If you’re a financial adviser, communicating with your clients about the changes and the impact on them and putting strategies in place to minimise the consequences are imperative.
What is changing?
Currently the asset thresholds (ignoring the value of an owner-occupied home) are:
- Single Homeowner $209,000
- Single Non-Homeowner $360,500
- Couple Homeowner $296,500
- Couple Non-Homeowner $448,000
The fortnightly pension payment reduces by $1.50 for every $1,000 over the assets test threshold. To put it into context, if a pensioner exceeds the asset test by $100,000, their pension reduces by $150 per fortnight, or $3,900 p.a. If they can earn more than 3.9% p.a. on that asset then they may be better off investing the money rather than taking the pension.
Post 1 January 2017, the asset thresholds will increase to:
- Single Homeowner $250,000
- Single Non-Homeowner $450,000
- Couple Homeowner $375,000
- Couple Non-Homeowner $575,000
But here's the sting. When assets exceed the new threshold, the pension will be reduced by $3 per fortnight for every $1,000 excess of assets. So if assets exceed the new threshold by $100,000 the pension would reduce by $300 per fortnight, or $7,800 p.a. Those assets would need to earn more than 7.8% p.a. for the pensioner to be better off. This will not be easy to achieve and may result in some people reducing their assets and putting the money into their family home to achieve a better pension outcome (although this may reduce available liquid assets by $100,000).
Don’t forget the income test
Of course, the pension is calculated under two tests: an asset test and an income test (with the one that produces the lowest pension entitlement being applied). In all the hype about the asset test changes it is important not to forget the income test. The government has not reported any changes to the threshold or taper rate for this.
The income test does not assume a portfolio of purely cash and fixed interest. The current deeming rate on the amount above $49,200 (single) or $81,600 (couple) is 3.25%, a rate of return that is hard to get in cash or term deposits. The income test reduces pension entitlement by 50 cents per dollar above the income threshold (about $4,264 for single and $7.592 for a couple), regardless of whether it is actual income or deemed.
Let’s look at some examples, starting with a winner …
Betty is a single homeowner with $248,000 of assessable assets outside her home.
Her pension entitlement now is $819 per fortnight, and post 1 January 2017 her pension will be $877 per fortnight if the majority of Betty’s assets don’t produce income: for example cars, caravans, boats, vacant blocks of land and trusts don’t produce taxable income.
But what if Betty’s assets were primarily income producing? If she has $240,000 in investments and $8,000 in personal assets, then she is still a pension winner but her pension will increase by only $4 per fortnight not $58.
Now let’s look at those who will stay the same, which is basically anyone who is currently receiving the full pension. Why? Because the changes will increase the asset test thresholds but anyone on a full pension is already under the required level.
Kevin is a single homeowner with $130,000 in investments and $20,000 in personal assets. He is entitled to $877 per fortnight under the asset test and the same under the income test. From 1 January 2017, his pension will remain the same.
As an example of how people will lose out under these changes, Fred and Shirley are homeowners with $600,000 in investments and $50,000 in personal assets.
They currently receive $792 per fortnight of pension entitlement (combined) and they earn $15,000 p.a. from their investments, meaning that their combined annual income is a little over $35,000.
Post 1 January, their pension will drop to around $497 per fortnight (combined), which means that their combined annual income (assuming they continue to earn $15,000 p.a. from their investments) will be around $28,000.
The major consequences
There are a couple of key messages the government is sending to retirees in these changes. The first is that the means-testing arrangements are likely to get tougher not easier and the second is that cash and fixed interest investments are not risk free.
If investment returns are not sufficient to meet the cash flow needs of retirees, they will be forced to dip into their capital. Sure, if the investments are in cash or term deposits, they are not at risk of the same volatility as they are in shares. However, the irony is that avoiding the potential drop in the value of the investments due to market volatility doesn’t mean they are preserving the value of their capital. It’s just that the retiree is eating it, not the market.
The bottom line is that retirees need to take more responsibility (and maybe a little more risk) in meeting their retirement income needs. While these changes are the biggest we have seen in nearly 10 years, don’t expect they will be the last for another decade.
Rachel Lane is the Principal of Aged Care Gurus and oversees a national network of financial advisers specialising in aged care. This article is for general educational purposes and does not address anyone’s specific needs.