While recent attention has been on possible changes to the tax and superannuation rules that might impact people’s financial situation (Read Bruce Brammall today: CGT winners are DIY), the reality for many is that a significant actual change to the Age Pension has passed through parliament (some time ago) and is now less than 12 months away with January 1 next year the key date to keep in mind. It is a change that will see the Age Pension reduced for many people.
The change stems from changes to the asset test for age pension eligibility.
The threshold for someone receiving the full age pension has actually increased a little – so that more people will receive a full Age Pension. For example, a single homeowner will be able to have $250,000 of assets, up from $205,500 currently, and still receive a full Age Pension. A home-owning couple will be able to have $375,000 combined, up from $286,500 currently, and still receive the full Age Pension.
Table 1 – Asset Test Thresholds for Access to the Full Age Pension
Threshold from January 2017
This change will be positive for those people with a level of assets at or around this new asset test threshold – they will end up with slightly higher levels of age pension.
The second part of the change is that the rate at which the age pension reduces as assets go above the new thresholds doubles from the current rate. Currently, every extra $1,000 of assets sees a fortnightly reduction in the Age Pension of $1.50. The rate at which the Age Pension will reduce from January 1 2017 will be $3.00 per fortnight for every extra $1,000 of assets.
To put these figures another way, at present for every extra $1,000 of assets you currently have above the bottom threshold, you lose $39 in Age Pension over the year.
The change will see a person lose $78 in Age Pension every year for every extra $1,000 of assets.
Another way to think of these figures is that every extra dollar of assets currently has a “return” of negative 3.9 per cent in the form of a pension reduction, and this will increase to -7.8 per cent from January 1 next year. This maths shows a key challenge with this policy change. Currently assets have to earn 3.9 per cent per year (well under the level of gross income from many Australian share market investments) to make up for the loss of Age Pension. As this rate of pension decrease becomes 7.8 per cent, this will be much harder.
Current Upper Thresholds
Upper Threshold from January 2017
Before looking at a number of possible responses to this change, it is worth commenting that people react very differently to the Age Pension, and this will influence the strategies that they choose. Some people, for example, will do everything that they can to access as much Age Pension as possible. Others will be just as passionate about being financially independent, and will do as much as they can to organise their financial situation to avoid accessing the Age Pension.
The following strategies are for those people with assets toward the higher end of the asset test range, or with assets just above the upper threshold that would allow them to receive a part age pension.
Strategy 1 – Increasing growth asset exposure in your portfolio
This strategy is a tough sell, given the market volatility over the past seven years. The justification for considering an increase in the exposure to growth assets is a combination of the higher rate of return from growth assets (for example Australian shares) over long periods of time, and the increased safety net the Age Pension now provides.
The increase taper rate means that if a person’s assets fall because of a fall in the value of their growth investments, then the rate at which the age pension will increase doubles from its current settings.
This provides a safety net in the case of market volatility. As investors weight up their response to these pension changes, they might be prepared to accept more portfolio volatility with increased exposure to growth assets like shares, in the knowledge that if markets and their level of assets fall, they will be supported with increased age pension payments.
Strategy 2 – Being prepared to draw more from your portfolio
In a similar justification to strategy 1, you might be prepared to draw on your investment assets at a more aggressive rate, in the knowledge that the Age Pension provides a better “safety net” as the value of your assets decrease. A couple with $800,000 in investment assets might have targeted a drawing rate of 4.5 per cent per year. This will give them income of $36,000 per year, and they would generally be comfortable that this is a conservative drawing rate provided their portfolio has reasonable exposure to growth assets like Australian shares.
This will almost certainly result receiving no part age pension (as they are likely to have non-investment assets that will push them over the $823,000 upper threshold of assets). They might choose increase their portfolio drawing rate to 5.5 per cent, a total of $44,000 per year, in the knowledge that if their assets drop, they will start to receive some part age pension.
The ASFA retirement standards suggest that the amount of income you need in retirement tends to decrease as you get older – suggesting a higher drawing rate earlier in retirement is a strategy worth considering.
Strategy 3 – Bringing forward expenditure
For those people with large expenses on the horizon, it might be a time to consider making those payments prior to the January 1 next year. $20,000 spent on a cruise also means $20,000 less on the assets test, which is an extra $1,560 per year in pension payments.
If you have always been thinking about spending some money on a big ticket item, perhaps the once in a lifetime holiday that you have always looked forward to, now might be the time.
Strategy 4 – Thinking about upgrades to the home
While a person’s principal place of residence remains exempt from the assets test, it might be time to consider any expenditure that needs to be made around the house. Funds spent on improving the house have the dual benefit of both improving the home, and decreasing the level of assets included in the asset test.
We know that these changes are coming – January 1 2017. They do change the retirement landscape significantly for those people with a level of assets around the upper threshold of the assets test. With a little over nine months until the changes take effect, there is still time to adjust to the upcoming changes.