The age pension – is it under threat?
Financial planners sometimes warn their clients that the age pension is vulnerable to political risk. This means that the federal government may tinker with it further, making it harder to rely on it for retirement plans.
“With the strike of a pen, there’s a risk that the age pension could not be there in some shape or form. It’s certainly not going to be easier for people to get the age pension,” says Darren James, financial planner with MBA Financial Strategists.
Planners such as James have a point. The government keeps changing the rules, arguing that an ageing population is putting pressure on the budget. First it raised the pension age to 67 for people born on or after January 1, 1957. For anyone born on or after July 1, 1952, it is now 65½ years.
Then the government tightened the assets test from January 2017. These changes have affected more than 400,000 people. Around 91,000 have lost their pension altogether and a further 235,000 have seen their part pension reduced. On the upside, 171,000 are expected to be better off, with around 50,000 who previously received a part payment now eligible for a full pension. A further 120,000 on a part pension are expected to have their payment increased by $30 a fortnight.
However, the government assures us that the age pension will always be available.
Ross Clare, director of research at the Association of Superannuation Funds of Australia (ASFA), who wrote a report on The Age Pension, Superannuation and Australian Retirement Incomes, argues that the current age pension system will remain affordable well into the future. He says that while financial planners try to scare people about the age pension, it will always be around because it is affordable for the Australian economy. “The Australian government spends under 3% of GDP on the age pension. It is more affordable for the government in Australia than just about any other country.”
The full age pension is around 28% of average weekly earnings and on its own just about satisfies the ASFA standard for a “modest” lifestyle in retirement. That excludes holidays, eating out, bottled wine, paid leisure activities and home repairs.
Of the 80% of retirees who receive the age pension, two-thirds get the full amount while a third receive a part payment. Government projections suggest that under current rules by 2050 75% will receive the age pension, with a third qualifying for the full rate and two-thirds on a part pension.
James says that even though the assets test was recently tightened, eligibility is still generous. For example, the home isn’t counted and pensioner couples owning a home are allowed to hold more than $800,000 in assets. “Also you can earn quite a lot of money before the age pension is cut off,” he says.
A bonus in qualifying for a part pension is the pensioner concession card, which provides a range of discounts that can be worth, depending on your needs, around $5000 to $6000 a year. It gives pensioners access to cheaper pharmaceuticals as well as benefits offered by state governments on property and water rates, energy bills, car registration and public transport.
In the GFC, self-funded retirees became eligible for the age pension because sharemarkets halved, slashing the value of their assets. This is a good example of how the pension provides insurance against investment or market risk. It also protects against inflation risk and longevity risk.
“We have clients with modest super of $400,000 to $600,000 and they have a small mortgage. The ASFA numbers are just a guide. It all depends on what the comfortable lifestyle means for our clients and how they adapt. In most circumstances they can get by quite comfortably unless they have an ostentatious lifestyle.”
Once you decide how much money you will need to support your lifestyle in retirement, you can work out how much you need to save and how to go about it.
The first thing to do is make sure you have your assets in the right place.
Petersen says pre-retirees need to think of all the tools they have. “Be mindful of the mix between your super and the age pension. It is quite valuable. Use your house in your retirement and even consider reverse mortgages later in life.”
Be conscious that if you have an asset such as a house, you can use it later in life with a Centrelink reverse mortgage or a commercially available reverse mortgage. It is quite a powerful tool as long as it is used wisely.
Traditionally people don’t like running up negative equity in their home by taking out a reverse mortgage. But Greatrex says it makes a lot of sense.
“People want flexibility, they want to travel. They want to combine it with jobs that work around that. We want to avoid a society where people work until they are 70 and then they try and do all their travel in a wheelchair.”
Greatrex likes the movie The Holiday, where two women – one from England and the other from the US – swap houses. “It can work for people,” he says. “Too many people keep doing the same thing. I am always thinking, what can I do differently and better?”
Weigh up the costs, advantages and disadvantages of downsizing carefully. Petersen says people rarely consider the transaction costs involved with moving house – they can easily add up to $50,000 or more. A lot of single older women in particular grow tired of having to maintain their big homes and want to move. But often the stamp duty and transaction and moving costs can buy an awful lot of maintenance.
Greatrex encourages his clients to salary sacrifice to super, particularly with the new, lower contribution cap of $25,000 a year. He is a big fan of self-employed contributions and early salary sacrificing.
He says it is more important than ever for younger people – even those with a mortgage – to contribute higher amounts to super. “It is harder for them to catch up. It’s not going to get any better. Yes, you will have a bigger mortgage for longer but the money will grow in the super fund. If you still need to knock out the mortgage when you retire, you will have the money in your super to do it.”
After 40, when the mortgage is being paid down, HLB Mann Judd’s Caputo recommends salary sacrificing up to the maximum concessional amounts.
DON’T SPEND YOUR PRECIOUS CAPITAL
One of the clever strategies is to live on the income from your account-based pension rather than draw down the capital. When you are over 60, all income from an account-based pension (capped at $1.6 million from July 1) is tax free. If you spend your capital you are running down your assets and that can compromise long-term living standards.
“People do get surprised to learn that they are in a better position than they thought,” says Sharples-Rushbrooke. “Partly that is because if they take the minimum amount of return from their account-based pension, depending on how investment markets do – and you have to be careful about projections – if you are drawing down 5% and your investments are earning 5%, then your underlying capital isn’t going down.”
“A lot of people don’t realise this. What this means is that they may not need as much as they think they do.”
Clare points out that the ASFA retirement standard is based on superannuation savings of $640,000 for a couple who own their own home. If retirees draw down the minimum amount, money will run out at 92, depending on how they invest.
INVEST IN LONG-TERM GROWTH ASSETS
An appropriate investment strategy and asset allocation are crucial in your retirement, as that provides you with income. Caputo recommends you have 70% of your account-based pension in growth assets. “Taking a long-term view, where your capital is not required for at least three years, and an investment allocation favouring growth assets such as Australian and international shares, it could generate an average annual return of 7% before inflation,” says Caputo.
Caputo has crunched the numbers to show the difference between getting 7% (5% after inflation) and 3%:
Jenny has $475,000 in an account-based pension that she combines with the age pension. She invests in growth assets and receives 7%pa over 20 years. She draws down around $23,000pa. At the end of the 20 years, her account-based pension has climbed to $858,000.
In contrast, Joel has opted for a more conservative investment that earns 3%pa. He draws down the same amount as Jenny, $23,000pa, but because of the lower return he has only $255,710 in his accountbased pension – $600,000 less than Jenny. The only variable is the earnings rate.
A return of 3%pa would drastically change the 20-year outlook, says Caputo. “These scenarios demonstrate a secure cash-type portfolio, where there is likely minimal capital growth. Long-term investors should have an allocation to equity investments in order to achieve reasonable returns, particularly in the current lowinterest-rate environment.” Of course, equity investment is not without risk but with dividend
yields (including franking) much higher than interest rates at present there is compensation for the risks.
Financial planners such as Sharples-Rushbrooke avoid annuities, which pay a guaranteed income. “Because the investment risk has shifted to the insurance company, they are pretty conservatively invested, particularly with cash rates so low at the moment,” she says “They don’t provide the good investment return but what they do provide is peace of mind for very nervous investors.”
HOW TO QUALIFY FOR THE PENSION
There are some things that you can potentially do to structure your assets and income to get the age pension, says Sharples-Rushbrooke.
If you have too many assets and you want to receive the age pension, possible strategies include:
• Upgrading your home. There’s no need to live in uncomfortable or shabby surroundings. “Update the bathroom, update the kitchen,” says Petersen. “Every dollar you spend to get your house up to stand- ard, it will get you closer to the age pension. Obviously you have to have the money.”
• Travelling. If you have always wanted to go on that big world tour, do it. “It is important that people are conscious of health issues later in life and bring forward plans like the big trip. Don’t put off your plans because of the cost,” says Petersen.
Giving it away. You are allowed to gift $10,000pa or a maximum of $30,000 over five years. If you give away more than $10,000 it is still counted in the age pension asset test for the five years after it was given away. “Centrelink looks at anything in the five-year period before you retire. If you give your child a block of land, for example, the value of that block of land will count to the age pension for five years,” says Sharples-Rushbrooke.
If you gift too many assets too soon, you might be in a situation where you don’t have enough left. “People are living longer and they underestimate how much they may spend all the time. It is very easy to spend money and it takes much more time to accumulate it,” says Greatrex.
• Buying a funeral bond. Money invested in burial plots, pre-paid funeral plans or funeral bonds up to the allowable limit of $12,500 (as at July 1, 2016) is not subject to the asset or income test for the age pension. You can invest in a bond through an investment company, such as a friendly society or life insurance company, or directly from a funeral director.
• Using the age gap. If you are a couple and there is a difference in ages, it is possible for the older person to receive the age pension while the younger one continues in the workforce, since their super isn’t counted as an asset. “The income test is a bit more favourable than the assets test because you can earn up to $77,000 as a couple before the age pension cuts out, so the younger one can continue to work and the older one can get the age pension,” says Sharples-Rushbrooke.
Under the income test the fortnightly age pension ($1339.20 including supplements) is reduced by 50¢ per $1 of income above $292 a fortnight. At a combined income of $2970.40 a fortnight ($77,230pa) there is no entitlement.
For singles, the fortnightly age pension ($888.30 including supplements) is reduced by 50¢ per $1 of income above $164. At an income of $1940.60 a fortnight ($50,456pa) there is no entitlement.