Pension pinch: The assets test challenge

I have just been looking at the detail of the new assets test for those who are part reliant on the government pension. 

The new changes are potentially horrific, and I am sure many Eureka Report readers will be affected. And if you are not affected personally you will certainly know people who are set to be hit, so we need to discuss at least the broad strategies that should be considered to adapt to the test.

And then I want to talk about why coal and iron ore are performing so well and canvass the possibility that the Australian economy may perform better than we expected, and that could include the firming of the inflation rate. 

Assets test

But first, the assets test. Let's work on a couple that have a house, but the same principles apply to a single person and to those who don't have a house. 

Right now a couple can have assets outside the family home of just over $1.17 million and still draw a part-pension. As their assets fall, so that pension increases. It has represented a comfortable lifestyle for a great many retired couples in Australia. And now that ends. 

At the bottom end of the pension scale a couple can currently have a combined asset base of $296,500, excluding the home, and gain the full pension. As of January 1 next year the amount of assets they are allowed to have while still receiving a full pension rises to $375,000. But to fund that greater pension entitlement comes a savage attack at the other end. 

Instead of being able to have some $1,178,000 in investments and other assets and still gain a part-pension, the pension cuts out when your assets – excluding the home – exceed $816,000. That is a huge reduction. And because the difference between full pension allowable assets of $375,000 and the cut-out level of $816,000 is only $441,000, there are bizarre consequences. 

Let's take a couple with just over $816,000 in assets outside the home as at January 1, 2017. They will get no pension whatsoever. But if they reduce their assets to $375,000 they will get a full pension of some $34,382 per year. That equates to a theoretical tax-free 'return' of 7.8 per cent on the $441,000 asset reduction. And that 'return' rate of around 7.8 per cent is also applied to single people and those without a house – it's just that the amounts involved are different.

There is no way that a retired couple are going to earn 7.8 per cent on that $441,000 without taking considerable risks, so the government is basically telling them that they should begin to live on their capital and, as they do, that their income will be protected because they will get a greater pension. It won't be a smooth curve because adjustments are made over time. 

But that is the principle. If a person is involved in this sort of game and wants to downsize their dwelling and get some cash, it may immediately slash their pension. So the harshest advice you will be given is to go off and have some cruises and let the government increase your pension. 

The retired people I know that have between $375,000 and $816,000 don't really want to run down their hard won savings like that, and the gifting rules make it extremely dangerous to give the money to your children or grandchildren. 

Because the pension rules are complex, you will need help. But my basic advice is that given the government is encouraging you to run your asset base down in ordinary living, so you should at least consider that as an option. 

However the government also wants you to work, so there are rather generous allowances for work income. And so it might be possible for some retired couples to extend their working life to compensate for the pension loss – but it's not an easy process.  

If you are approaching retirement you need to look at this new situation with great care, because it will involve different strategies. You may decide to work longer. You may decide well before you retire to help your children. You may decide to increase the size of your house, because that is a protected asset. 

In the larger house, maybe your children can live with you if they can't afford their own home. These are some of the basic questions that this commentary can't answer, because each person is different. But they are some of the considerations that you will need to discuss with your spouse, your family and your advisors. 

It is not a happy picture for people who based their retirement on the returns from $1.1m plus the pension. The measures were clearly designed by people who do not understand the retirement business. 

It might save the government money in the short term, but in the long term it will encourage people to organise their affairs so that they rely more on the government pension and protect their asset base with the domestic home. 

In some cases the pension can be maximised via a retirement village accommodation, but be very careful of this because it bristles with traps. 

Coal and iron ore

To more pleasant subjects.

The rise in the price of coal is truly stunning. Australia's second-largest export has increased some 145 per cent since the mid-year and is still rising. The reason for the increase is that China has decided to reduce its high-cost coal production and, as a result, there has been a huge increase in demand for Australian and other coals. We are looking to open new mines. 

To some extent the same thing has happened in iron ore, where the Chinese have also cut back production. My understanding is that the Chinese have been shocked by the increase in the price of coal and will look to restart some of their production again.

In the meantime, the Australian economy will get a considerable boost once current contracts are completed. Iron ore represents 15 per cent of our exports and coal around 11 per cent, and overall we have seen a considerable rise in other commodities as well. 

That change in outlook for commodities will have a number of important effects on the Australian economy. First and foremost, it will boost Queensland and Western Australia. But second, it means that the Australian dollar will be underpinned, although, as we all know, the interest rate differential between Australia and the US is just as important. The markets are telling us that the US interest rates are about to rise; the Reserve Bank is looking to reduce rates in Australia, but there is now no certainty that it will.

And remember, we have a situation where rural commodities, oil, as well as many other products have increased in price in the last six months, and that is going to creep into inflation. 

I think that the extremely low levels of inflation Australia is experiencing will change, and that means that inflation-protected assets will come back into favour. When inflation is very low no-one thinks about that particular attribute of a security.