Essential retirement client conversations in 2016
Minh Ly takes a look at the impact of some recently legislated changes to the Age Pension and Aged Care rules and how they can form part of client conversations.
An ongoing relationship with your client can be instrumental to achieving successful retirement outcomes.
Continuing relationships can make it easier to regularly review the client's strategies in light of personal, financial and legislative changes.
Age Pension
With about 75 per cent of people over 65 on some kind of government pension , the Age/Service Pension provides ‘bedrock' income for the majority of retirees.
It is then natural to expect that a priority for retirees would be to understand the effect of any Age Pension changes. Given the complexity in this area, it is a clear opportunity for advisers to demonstrate their value to retiree clients.
There are three key changes that are likely to be part of client conversations this year.
Changes to the deduction amount for defined benefit income streams
Until 31 December 2015, the deduction amount for the Centrelink/Department of Veteran Affairs (DVA) assessment of defined benefit income streams was equal to the tax-free component of the annual income payment.
Since 1 January 2016, the deduction amount is capped at 10 per cent of the annual income payment, except in the following schemes:
- MilitarySuper;
- Defence Force Retirement and Death Benefits Scheme (DFRDBS); and
- Defence Force Retirement Benefits Scheme (DFRBS)
Assets Test threshold and taper rate will change
From 1 January 2017 the Assets Test lower thresholds will increase and the taper rate will double from $1.50 per $1,000 per fortnight to $3 per $1,000 per fortnight.
This will result in a substantial reduction to the asset cut-out threshold as shown in the table below.
For a number of clients, these changes may mean a reduction in their Age Pension, which may be as high as $14,467 per annum if they are a pensioner homeowner couple.
Increasing Age Pension age
Age Pension age for clients turning 65 from 1 July 2017, will increase to 65.5. Those born in later years will see their pension age increase as shown in the table below.
Adviser opportunities
1) Clients affected by the 1 January 2016 defined benefit changes are likely to have seen a reduction in their Age Pension entitlement, off the back of an increase in their level of Centrelink/DVA assessable income.
Where a client's Age Pension entitlement is determined under the Income Test, reducing the amount they have invested in deemed financial assets can help reduce their Centrelink/DVA assessable income and help improve a client's pension entitlement.
Investment strategies that can help reduce deemed financial assets include:
- Where appropriate, purchasing exempt/non-financial assets such as funeral bonds and collectibles, as Centrelink/DVA does not attribute those assets with assessable income;
- Investing in assets that produce lower assessable income than deemed income. For example, lifetime annuities or an insurance bond inside a trust; and
- Protecting grandfathering of pre 1 January 2015 account-based pensions (ABPs).
Example 1:
John is aged 65, single and has $300,000 of deemed assets. This generates $9,021 per annum of assessable income for social security purposes.
If the $300,000 was instead invested into a lifetime annuity that paid annual income of $15,000, it would generate no Centrelink/DVA assessable income as the annual payment is less than the $15,608.74 deduction amount.
2) The 1 January 2017 changes to the Assets Test will impact some retirees more than others. For example, couple homeowners with $823,000 of assessable assets on 1 January 2017 will lose about $14,500 per annum combined in Age Pension while couple homeowners with less than $300,000 of assets are unlikely to see a change in their entitlement.
For those seeing a reduction in their Age Pension entitlements, discussing how they can continue to meet their cash flow requirements will be front of mind. It is also important to consider the impact of investment strategies on the client's long-term income needs, their estate planning decisions and access to liquidity.
The type of investment strategies to help a client improve their Age Pension entitlement will vary depending on which Centrelink/DVA test applies. For those assessed under the Income Test, investment strategies which can reduce their overall level of Centrelink/DVA assessable income will help improve their Age Pension entitlement (see adviser opportunity 1).
For a client who is assessed under the Assets Test, identifying investment strategies that can reduce their overall level of Centrelink/DVA assessable assets will be a key consideration. This could include:
- Bringing forward renovations to the family home which can also have the effect of reducing ongoing living costs and/or increase comfort in retirement;
- Investing up to $12,250 into funeral bonds for each person;
- Prepaying funeral expenses;
- In cases where the spouse is below Age Pension age, consider contributing money to their superannuation fund;
- Gifting (up to $10,000 annually and $30,000 over five years); and
- Investing in a lifetime annuity which provides the retiree with regular income and benefits from a reducing asset value.
Example 2:
Tim and Sarah (both age 65) are a couple who own their home, have $30,000 in personal assets and $300,000 each in an ABP that commenced in July 2015.
As illustrated in the chart below, if Tim and Sarah invest $90,000 each into a lifetime annuity (using money from their existing ABP), they may be able to improve their Age Pension entitlement by about $46,000 over 15 years compared to retaining those funds in an ABP.
Proposals still being debated in parliament
It's important to understand the changes that have been legislated because of their impact to retirement plans.
Also of importance are the proposals still being discussed as they can inform current planning decisions.
The Social Services and Other Legislation Amendment (2014 Budget Measures No. 5) Bill 2014
This bill was introduced into parliament on 2 October 2014 and as of 3 February 2016 had not yet passed either house.
It has three main proposals:
- Gradually increase Age Pension age to 70;
- From 1 July 2017, maintain the Income Test free areas for three years for most pensions, including the Age Pension; and
- From 1 July 2017, reduce the deeming thresholds to $30,000 for singles ($48,600 as at 3 February 2016) and $50,000 for couples ($80,600 as at 3 February 2016) and maintain these thresholds until 1 July 2020 when they will be indexed.
Proposal to align the assessment of the former home with the aged care rules
In the Mid-Year Economic and Fiscal Outlook (MYEFO) released on 15 December 2015, the Government proposed to align the assessment of the former home for Age Pension with the aged care assessment.
If legislated, this would mean that for new aged care residents from 1 January 2017, rental income would be assessed for Age Pension purposes as well as aged care purposes, regardless of how the resident chooses to pay for their accommodation.
Further, the exemption of the former home received when a resident pays a Daily Accommodation Contribution (DAC) or a Daily Accommodation Payment (DAP) and rents out the home, would be removed.
There was no mention, however, of removing the automatic two-year exemption on the former home under the Assets Test upon entry into residential aged care.
Residential aged care
Further changes to Australia's aged care system commenced from 1 January this year.
Similar to reforms that commenced on 1 July 2014, the changes are likely to increase the contribution new aged care recipients make towards the cost of their care.
Assessment of rental income from the former home
From 1 January 2016, new aged care residents have the rent they receive from their former home assessed under the Income Test for aged care purposes.
This is regardless of whether they are paying a DAC or a DAP.
Adviser opportunities
3) The inclusion of rent into the assessment of a resident's means-tested amount will likely mean higher means-tested care fees or DACs for new residents compared to those who entered last year (with all else remaining equal).
This change is likely to place added pressure on a client's cash flow and their ability to maintain the former home. In either case, clients looking to improve their cash flow could look at strategies which help reduce their ongoing means-tested care fee - which is based on an income and an asset assessment.
For instance, to help a client enhance their cash flow, they could use financial assets to:
a) Make an additional payment towards an outstanding accommodation amount. This can help reduce the client's ongoing accommodation costs, and in some cases, improve their Age Pension entitlement;
b) Invest in an insurance bond in a trust. This can reduce the client's overall assessable income, which also helps with reducing the means-tested care fee and improving the client's Age Pension (where they are being assessed under the Income Test); and
c) Invest an amount into an aged care lifetime annuity that, in addition to providing residents with regular income, interacts efficiently with the social security means tests helping to reduce means-tested care fees and improve Age Pension entitlements.
There are a number of important Age Pension and Aged Care changes that can affect a retiree's cash flow goals. These changes provide a clear opportunity for advisers to engage with clients, review their strategies and provide peace of mind that their client's long-term goals will be met.
Minh Ly is a senior technical services analyst at Challenger.
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