Steering around the pension assets test

Summary: With the taper rules around the pension assets test having changed, it's worth knowing the limits.

Key take-out: A well-planned allocation and drawdown strategy can deliver benefits.

In my previous article (Four key factors for retirees) I looked at one of the big challenges in the current retirement landscape.

I focused on the fact that, as of January 1, 2017, the taper rate at which people have their access to the Age Pension reduced for those holding extra assets. As such, a homeowning couple with $300,000 in retirement can possibly earn more income than a homeowning couple with $800,000 in assets.

The previous article set out some of the issues that impact someone in this position including:

• The way the Age Pension itself can act as a safety net as assets drop.
• The legislative risk (and we know how frequently rules around superannuation and the Age Pension have changed lately).
• The way income needs seem to reduce a little over retirement.
• Longevity risk – the chances of outliving your portfolio.

Having discussed those issues in the previous article, this article looks to set out a practical response to these issues.

It doesn't pretend to be definitive but looks at the thinking that can be used to build a retirement portfolio given the issues. We are particularly interested in the asset allocation decision of the investment portfolio (the split between cash like assets and growth assets like shares), and the ‘drawdown' decision – the rate at which we take money from our portfolio to live on.

Let's consider a homeowning couple. If your circumstances vary (you don't own a home or you are single), you can take the intuition of what is discussed and consider it against the different Age Pension assets test limits for different situations.

This homeowning couple also has $40,000 of lifestyle assets (car, furniture etc).

To build the portfolio, it is split into three ‘tiers':

• The value of the portfolio that sits below the Age Pension assets test threshold.
• The value of the portfolio that sits between the minimum and maximum assets test thresholds.
• The value of the portfolio that sits above the maximum assets test threshold.

The pension safety net

Let us start by looking at the investment and drawdown rate on the value of the portfolio that sits below the minimum assets test threshold. This is a crucial part of the portfolio because, if everything else is gone, it plus the Age Pension would still provide a reasonable retirement. It is the ‘safety net'.

In the case of a homeowning couple, they can have $387,500 in assets outside of the family home and still receive the full Age Pension. Taking into account the $40,000 of lifestyle assets, that leaves a portfolio of about $350,000 that would sit below the assets test threshold where the Age Pension starts to reduce.

The Age Pension for a couple is $35,568. Provided investment costs are kept low, then a sustainable withdrawal rate on a balanced portfolio is 5 per cent per year, which would see $17,500 withdrawn from the $350,000 portfolio – providing total retirement income of about $51,000 a year.

According to the Association of Superannuation Funds of Australia retirement standards, this is about halfway between a modest and comfortable retirement lifestyle. If this is seen as the ‘worse-case scenario' of a situation, then it is not too bad. It equates to income for a couple of nearly $1,000 per week.

In terms of asset allocation, because this is the most conservative part of the portfolio, the safety-net, a conservative 50/50 split between cash-like and growth (Australian shares, global shares, property) assets might be appropriate.

The middle assets band

We now move to build a plan for the value of the portfolio that sits between the lower and upper assets test thresholds, where every extra $1,000 of assets effectively reduces the annual Age Pension received by $78 per year – an effective loss of 7.8 per cent of income for every $1,000 of assets.

To be ahead of the rate that the Age Pension is lost, you need to draw on this part of the portfolio at the rate of 8 per cent per year. This is a high drawdown rate. But it is worth keeping in mind that if you find yourself with your level of assets falling, this is somewhat balanced by receiving extra Age Pension as your total assets fall.

Keep in mind that it is a personal choice: if you don't feel comfortable, then draw down at a lesser rate. The 8 per cent rate is proposed to keep you ahead of the Age Pension that you lose as your assets level increases.

A home-owning couple lose all access to the Age Pension when they have assets of $844,000. Considering the $40,000 of lifestyle assets, that leaves investments assets of about $800,000 to take the couple up to the threshold where they receive no part Age Pension.  

The first $350,000 of investment assets was dealt with in the previous strategy, so we are now dealing with the $450,000 that sits between the conservatively invested $350,000 and the $800,000 that takes the portfolio to the Age Pension assets test limit.

For this part of the investment portfolio I suggest a more aggressive asset allocation, because of the way that falls in the value of the portfolio (if growth assets fall) are supported by an increased part Age Pension, and because with an 8 per cent drawdown rate you will need reasonable exposure to growth assets to sustain this. On this basis, a 25 per cent defensive and 75 per cent growth asset allocation is suggested.

Strategies at the top end

Finally, we move to a plan for the assets in excess of $800,000. In a lot of ways this is the most routine to consider. We can look to drawdown at a sustainable long-term rate, so I would suggest 5 per cent per year, while using a balanced asset allocation, with perhaps 35 per cent in cash-like assets and 65 per cent in growth assets.

Table 1: Homeowning Couple: Possible Model for Asset Allocation and Portfolio Drawdown Rates Given Current Retirement/Age Pension Rules

Conclusion

I want to again emphasise that this is not a prescriptive solution – there needs to be a lot more thought than just broad-brush asset allocation rules.

I only suggest an 8 per cent drawdown rate as a response to the specific Age Pension rules that see income reduced at a rate of 7.8 per cent for additional assets.

However, what this discussion does provide is a way of thinking through the asset allocation and drawdown decisions, separating portfolios into three different levels.

The very conservative first $350,000 will provide, alongside the Age Pension, a really strong safety-net. The second tier between $350,000 and $800,000 can be invested more aggressively to try and allow drawdowns at an 8 per cent rate to replace the Age Pension lost as assets increase.

Lastly, the third tier can be invested with a sustainable asset allocation and drawdown rate.