Will age pension changes benefit you?

In a recent article (read more here: An investor's guide to looming age pension changes) I discussed the two changes to the assets test that are coming into effect in January 2017.

Change one sees the “taper rate” – the rate at which access to the age pension is reduced – increase. This is a negative for retirees who are affected by this, as they will lose access to the age pension more quickly as their level of assets increase.

Change two sees the level of the asset test, which starts to reduce the age pension when it reaches a certain threshold, increase (for example, from $286,500 for a home owning couple up to $375,000). This has been promoted as a positive. However, as a letter I received from Gordon points out, someone with $375,000 of assets is unlikely to be receiving the full age pension because they are likely to have their income reduced under the deeming rules and the income test.

There is certainly an element of illusion about the generosity of this increase in the lower asset test threshold.

This line of discussion does raise a couple of interesting points. The first is that the income test, and the deeming rules, will become increasingly important to age pension calculations. The second is that this change, the increased importance of the income test and deeming, is magnified by another recent rule change, whereby account based income streams (or account based pensions – basically pensions paid from a superannuation account) started from January 1 2015 are assessed as income under deeming rules. This generally results in a higher income amount than the previous calculation, again meaning more people will be impacted by the income test and related deeming rules.

What is deeming?

Deeming is a calculation that is used to proxy for investment income for age pension payments. Rather than trying to estimate or calculate the actual income earned for a year, a deeming calculation is done based on the financial investments that a person or couple own. The value of financial investments including bank deposits and term deposits, managed investments, loans made, listed shares and account based income streams are added together. They are then deemed to earn:

• 1.75 per cent on the first $48,600 of a single person's financial investments OR;

• 1.75 per cent on the first $80,600 of a pensioner couple's financial investments

• and 3.25 per cent on the balance above this figure.

Deeming on the minimum asset test threshold amount

Let's return to the initial observation – that a home owning couple with $375,000 in assets, which is the new lower limit of the asset test, will be caught under the income test and won't receive the full age pension after all. Let's assume that this couple has $40,000 in lifestyle assets, leaving $335,000 in financial investments – perhaps $50,000 in a cash account, $50,000 in a term deposit, $35,000 in shares and $200,000 in an account based pension started after January 2015. All these financial assets ($335,000) are assessed under the deeming rules.

The calculation (because they are a couple) is 1.75 per cent of the first $80,600, and 3.5 per cent of the balance ($335,000 - $80,600).

The total deemed income would be $10,315. This is a fortnightly amount of $397. For a couple, the income test means that income above $288 a fortnight reduces the age pension received by 50 cents for every extra dollar earned. In this case $109 per fortnight is earned above the income test threshold, meaning a $54.50 fortnightly reduction in age pension payments.

If deeming rates were to rise in the future, perhaps as a consequence of higher interest rates at some point, the deemed income would be higher and the reduction in the age pension greater.

As you can see from this example, raising the lower threshold of the asset test is not going to be as profitable as some people might be hoping – because of the income test.

The income test and pre-2015 account based income streams

The way that income is assessed for the Centrelink income test on account based income streams started prior to 2015 is likely to be more favourable that for those income streams started after 2015, where deeming rules are used. People with pre-2015 account based income streams need to be aware that if they change to another pension provider (including changing to or from an SMSF), try to put together multiple account based pension or cease to receive an income payment from an account based pension, they will see their account based pension lose the more favourable Centrelink treatment. It is important to do the calculations to understand the potential impact before making any changes to a pre 2015 account based income stream.

Conclusion

The income test, and consequentially deeming rules, are likely to become more important to people making retirement calculations. Those people retiring now are also impacted by a change made just over a year ago, where account based pensions are subject to deeming rules. A home owning couple who has heard the government announcement that the asset test level that will start to reduce the Age Pension will now kick at $375,000 should not get too excited, as they stand to have their pension reduced through the income test.