Scorched by new super changes

In the debate around government policy and the age pension, much is made of those people who receive the age pension, and the adequacy of it as a retirement income stream. Similarly, much is made of what is happening to the self-funded retiree as superannuation policy changes. Stuck in the middle is a group that does not seem to be as vocal, but is large in number – those people funding their retirement with a mix of their own investments and some part age pension.

National Commission of Audit figures show that 50 per cent of people in retirement rely on the full age pension, 20 per cent are self funded (receive no age pension) and 30 per cent receive some age pension.

This 30 per cent group is faced with a “perfect storm” of low cash interest rates, changing superannuation rules and changing age pension legislation that is making their navigation of retirement particularly challenging. 

The more punitive asset test from January 1, 2017 

The first factor that those people who are receiving a part age pension, or are likely to receive one once they get to retirement age, need to consider is the looming change to the asset test for the age pension. Currently, people lose $1.50 of part age pension a fortnight for every extra $1,000 of assets that they have over the minimum asset test threshold, which starts at $350,000 (the assessable amount includes money that may be in superannuation accounts).

From January 1, 2017 the “taper rate” will increase to $3.00 of age pension lost for every extra $1,000 of assets. The impact of this is that people funding their retirement with a mix of their own superannuation and investment assets, and some part age pension, will more than likely receive a reduction in their age pension payments.

A big impact of this is around the way people in this position look at risk. At the moment, the age pension is a largely “risk free” payment that they receive – separate from the volatility of investment markets. A reduction in this “risk free” income stream may see many become more conservative with their own investment and superannuation assets – leading to the second challenge, the low interest rate environment.

Record low interest rates

As part age pensioners see their age pension payments reduce and have to rely more on their own investments and superannuation to fund their lifestyle, it is understandable that they will look to shift some assets into the lower risk asset class of cash. The problem here is with returns – with record low interest rates it is hard to generate an income from cash investments.

From the January 1, 2017 a home owning couple with $850,000 of investment assets will receive no part age pension. If they tend toward a cautious asset allocation, they might choose to have 40 per cent of their assets in Australian shares and 60 per cent in cash. Assuming a gross yield on the Australian shares of 5.5 per cent, and two per cent income from their cash, this income will produce total income of $28,900. This is significantly less than the current amount of age pension for a couple of $34,250 (basic rate).

This leads to some really tough questions for someone in this situation. Do they accept higher volatility to try and increase their portfolio income through exposure to more shares? Do they try and chase a higher yield through some higher risk fixed interest investments? Do they draw down some of their investment capital, and use that to supplement their lifestyle?

Topping up close to retirement

My experience suggests that a lot of people who are approaching the financial position of funding their retirement with a mix of age pension and their own superannuation/investment assets rely on making fairly significant superannuation contributions close to retirement to boost their superannuation balances as much as they can. Up until this time their financial focus has often been on paying off their mortgage and raising their families. 

The concessional contributions (usually compulsory employer contributions and salary sacrifice contributions) limit proposed in this year's budget limit people to $25,000 per year. While there are provisions for “catching up” on previous contributions it still provides another limit on people getting money into superannuation close to retirement – and at a stage in their life when they can often afford to make larger contributions. 

What can be done?

The tough question is – what to do about all these changes? Three key steps seem to present themselves. 

1. For those approaching retirement, a focus on making more superannuation contributions earlier becomes more important. This allows the growth assets in the superannuation fund to be providing compounding returns earlier, as well as avoiding some of the restrictions of limited superannuation contributions. 

2. An income planning approach to asset allocation, whereby the next five to seven years' worth of income is invested in cash like investments, might help build some confidence about exposing more of the remaining portfolio to growth assets. 

3. Finally, modelling the consequences of effectively withdrawing some capital from superannuation assets each year might encourage. higher withdrawals earlier in retirement, and the rely more on the age pension later. Of course, the difficulty with this is the possible impact of future changes to age pension rules.