A pension strategy where everyone can win

Last week I talked about the fact that a combination of income from investments and superannuation, and from some part-age pension, was likely to lead to a retirement outcome that was better than many people thought.

Given that many people will not amass the $1.0865 million in assets (excluding the value of their home) that a home-owning couple can have to receive some part-age pension, or for single homeowners the $731,000 (excluding the value of their home) in assets that they can accumulate while still receiving some part-age pension, it is an important topic for many people planning their retirement.  Many people retiring now have not had compulsory superannuation, and have experienced 10 years of poor investment returns, which will have negatively impacted their retirement position.

As I looked at in last week’s article (Pension plan adds up to better returns), receiving some part-age pension can provide a useful buffer against a drop in investment prices – helping people to weather difficult times.  As asset values fall (such as during the global financial crisis), income from the age pension will increase.

In this article I look at the end game. How much income will be received given a certain level of assets?

In working out the amount of age pension to be received, the Federal Government has set two tests – an income test and an assets test.  The calculation used to work out the amount of age pension received is the one that is most restrictive of a person’s age pension, which is mostly the assets test.  On that basis I have done the calculations around the assets test.  I have also used the situation of homeowners – both singles and couples.  That is because it is the more common retirement scenario.  For those people who are not homeowners, the intuition behind the calculations is the same. It is just that the asset test limits are higher, resulting in a higher level of income.  A non-homeowner might also be eligible for rent assistance.

To start putting together some calculations of how much total income a person or couple in retirement will receive when they have some investments themselves and receive some part-age pension, we need to think about an appropriate rate at which to draw income from our investment and superannuation funds.

Drawing from investments

Guidelines for Withdrawal Rates and Portfolio Safety During Retirement, by John J Spitzer, Jeffrey C Strieter and Sandeep Singh of the State University of New York, appeared in the US Journal of Financial Planning in October 2007.  It looked at how likely you were to run out of funds during a 30-year retirement.  This is a reasonable timeframe – someone retiring at age 60 and living to 90.

They found that with a portfolio that had a 60% exposure to growth assets (shares and property), a person had about a 12% (one in eight) chance of running out of money while drawing at a rate of 4.5% a year, increasing their drawing each year in line with inflation.

This seems like a reasonable starting point. Let’s assume that the person/couple in retirement draw from their investments at a rate of 4.5% a year.  This means drawing $4,500 of income for every $100,000 invested.  Now, this is quite a conservative drawing rate and many people might feel comfortable drawing at a rate of 5% or 5.5% a year. However I will stick with this conservative figure.

Calculating the age pension

For simplicity, I am going to ignore some of the smaller payments (such as the pension supplement) around the age pension and just focus on the core age pension payment.  Information about the full retirement situation can be found from www.centrelink.gov.au.

The basic rate for the age pension is $733 per fortnight for a single person, or $1,106 (total) per fortnight for a couple. As a person/couple’s assets go over a set limit, the amount of age pension that they receive falls.

For a single homeowner that amount is $192,500, and for a home-owning couple that amount is $273,000.  That is, a single can have $192,500 of assets and still receive the full age pension and the home-owning couple can have $273,000 in assets and still receive the full age pension. Once their assets go over this amount, their age pension is reduced by $1.50 per fortnight for every $1,000 they are over that limit.  So, if they are $100,000 over this limit they will lose $150 in age pension every fortnight.

There is a long list of ‘assessable assets’ for the assets test, including cash, superannuation, investments and lifestyle assets like furniture, boats and cars.  The value of these lifestyle assets is assessed as ‘what you would get for them if you sold them’.  So a car bought for $30,000, but which would be sold for $7,000 today, has a value of $7,000.

Putting everything together

So, to the big question.  How much income will I get given various levels of assets?  I have done the calculations for a home-owning couple, and a home-owning single person.  In each cash I have assumed $50,000 of ‘lifestyle assets’, and the balance of the assets being drawn on (used for income) at a rate of 4.5% a year.

It is worth commenting at this stage that for various reasons, including the impact of the ‘Senior Australian Tax Offset’, that there is almost certainly no income tax to be paid.

Calculations for a Single Homeowner: Fortnightly Income

Calculations for a Home-owning Couple: Fortnightly Income

Calculations for a Single Homeowner: Annual Income

Calculations for a Home-owning Couple: Annual Income

So what?

Even though the basic age pension is difficult to live on, adding $250,000 of investments assets (and $50,000 of lifestyle assets) sees a single homeowner receiving a total of more than $500 a week tax-free to live on. A home-owning couple, with a similar level of assets, receives $750 a week. If the people in these scenarios own their home with no mortgage, then I suspect that this is a reasonable position to be in.

These calculations are also based on a conservative drawing rate from investment and superannuation assets of 4.5% a year.  If you are receiving some part-age pension, you may choose to withdraw at a slightly higher rate than this, given that you have the age pension safety net in place.

Conclusion

The age pension will be an important source of income for many people considering their retirement situation.  While the basic age pension certainly does not allow for an expansive lifestyle, adding income from investments and superannuation makes the tax free total income stream increasingly attractive.

Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.