Age pensions and super income streams: Lifting the fog - Part 1

The rules for age pension entitlements will change on 1 January. Richard Livingston and Liam Shorte explain the rules and how to get the most from them.

Key Points

  • Under existing rules, account based (super) pensions generously treated
  • The operation of the existing rules explained
  • A strategy to maximise your age pension entitlement  

Superannuation income steams (account based pensions) are exempt from income tax and, currently, treated generously when working out your age pension eligibility.

Come 1 January 2015, the rules will change for pensions taken after that date. Let’s take a look at how the rules work now (in Part 2 we’ll cover the changes).

The current rules

Eligibility for the age pension and ‘deemed’ to earn a certain amount of income and different rules apply to certain types of income, including account-based pensions paid by super funds.

The ‘cut-off’ income (where no age pension is paid) for a single is currently $1,841.60 per fortnight ($2,817.20 for a couple). Singles can earn up to $156 per fortnight ($276 for couples) and get the full pension (above this level it gradually reduces). More details can again be found on the Human Services website.

Let’s take a look at how the Income Test works in practice.

Deeming

Under the deeming rules, financial investments (such as shares and term deposits) are regarded as earning a certain rate of return, regardless of what is actually earned. Depending on the size of the investments, Centrelink will currently deem them to have earned 2.5% or 3.5% (see Table 1).


Amount of financial assets Deeming rate
Table 1: Current deeming rates for age pension
Single  
First $46,600 2.00%
Excess of $46,600 3.50%
Couple (where one gets age pension)  
First $77,400 2.00%
Excess of $77,400 3.50%
Source: www.humanservices.gov.au  

To the ‘deemed’ income on financial assets, most people will have to add any superannuation pension or annuity income received (as well as net investment property rental income and any income over $250 per fortnight from employment). But the amount added to reflect the super pension is reduced by a ‘deductible amount’.

Deductible amount

The ‘deductible amount’ is calculated as follows:

Deductible amount = (Original purchase price - any commutations)/Relevant Number

The Relevant Number is the life expectancy when the pension is commenced (calculated from the Australian Government life expectancy tables). The shorter the life expectancy, the less income that gets included in the Income Test. Table 2 shows how the deductible amount is calculated.

Steve’s starting account based pension balance $300,000
Table 2: ‘Deductible amount’ example for Steve (aged 65)
Relevant number (2) 18.54
Deductible amount Calculated as $300,000/18.54 = $16,181
Minimum pension (3) $15,000
 
Notes:
(1) No commutations (this will typically be zero).
(2) Relevant number calculated as life expectancy for a 65 year old male, based on life expectancy tables.
(3) Minimum pension calculated at 5% (for 65 year old) multiplied by $300,000 account balance. See ATO website for full list of minimum withdrawal amounts.

Assuming Steve has $100,000 outside of super, in cash and shares, he’ll be deemed to have earned $2,801 (calculated in Table 3), which will be his total income for the Income Test. If he’s got no significant assets apart from the super, cash, shares and his own home, he’ll qualify for the full age pension.

Steve’s financial assets  Deeming rate Deemed income
Table 3: Calculation of Steve’s ‘deemed income’
First $46,600 2.00% $932
Next $53,400 3.50% $1,869
Total   $2,801

If he had to include his account-based pension, or a substantial portion, he’d get a very different result. His age pension would fall once he exceeded $4,067 in annual income ($156 per week). The deductible amount shields the super pension from affecting his age pension.

Refreshing the deductible amount

As Steve ages and his portfolio returns more than the deemed return, he may want to start taking a larger super pension. But once he goes beyond the $16,181 deductible amount, the excess will be included in the Income Test for the age pension.

One potential strategy is to refresh the deductible amount by closing the account-based pension and starting a new one. Assuming no change in purchase price ($300,000), doing this at age 75 would increase his deductible amount to $26,525 (calculation in Table 4).

Steve’s starting account based pension (ABP) balance $300,000
Table 4: Example for Steve (aged 75), showing effect of ‘refreshing’ deductible amount
Relevant number(1) 11.31
Deductible amount Calculated as $300,000/11.31 = $26,525
Minimum pension (2) $18,000
   
Notes:  
(1) Relevant number calculated as life expectancy for a 75 year old male, based on life expectancy tables.
(2) Minimum pension calculated at 6% (for 75 year old) multiplied by $300,000 account balance. See ATO website for full list of minimum withdrawal amounts

If he took a $25,000 account based pension annually, he’d still be entitled to the full age pension; the higher deductible amount shelters the larger super pension.

You should seek personal advice on this (and any) strategy since it may have other complications. Plus, it probably won’t work after 1 January 2015, as starting the account based pension afresh would subject it to the upcoming rule changes, which we’ll cover in Part 2.

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