Making the most of the assets test changes
Minh Ly looks at what advisers need to take into consideration once the asset test changes have been implemented.
Many retirees will be required to review their current retirement income strategies in light of the rebalanced pension assets test from 1 January, 2017.
For example, homeowner couples can see a reduction in their pensions by up to $14,122 ($9,798 for single homeowners) that will need to be replaced if a particular retirement lifestyle is to be maintained.
The upcoming assets test changes provide advisers with the opportunity to discuss various options available to clients and explain the various implications.
This article will delve into these considerations and take a closer look at the various short and longer-term implications to a client's overall retirement outcome.
What does 1 January mean?
The rebalanced pension assets test effective from 1 January 2017 will:
1) Have higher assets test thresholds (table below); and
2) Double the taper rate from $1.50 to $3 per fortnight per $1,000 of assets.
The increase in the assets test thresholds allows clients to hold more assets before their pension starts to reduce. For some clients with lower asset levels, this may lead to higher pension entitlements. For others, the income test will continue to determine their entitlements.
The second change is to increase the taper rate. This change will reduce Age Pension entitlements at a faster rate once assessable assets exceed the new assets test thresholds.
The largest reduction in pension entitlements will occur at the new assets test cut-off thresholds (table below). Pensioners with assessable assets above the new cut-off will see their pensions reduce to nil such as in Matt and Lynn's case.
Cashflow and other important effects
The immediate impact with a reduced (or lost) pension is a reduction in cashflow. However, there are also two other important effects.
The first is the loss of grandfathered status on existing account based pensions (ABPs). ABPs that commenced prior to 1 January, 2015 can only remain grandfathered if a pensioner continues to be in receipt of an income support payment such as the Age Pension.
Pensioners who lose their Age Pension entitlement on 1 January, 2017 because of the assets test changes will have their ABPs deemed. In many cases, this will lead to higher levels of assessable income going forward.
The other is the loss of the pensioner concession card (PCC) and the concessions it provides to pensioners. There are provisions in place to ensure those who lose their PCC because of the new assets test changes, are automatically issued with a low income health care card (LIHCC) and a Commonwealth seniors health card (CSHC)(if they are over age 65) without being subject to the relevant income test.
Managing the cashflow reduction
Some clients may simply review and tighten their budgets to offset the reduction (or loss) in their pensions. Others may find this approach challenging, particularly those facing a larger reduction in entitlements. It can also be difficult for clients who are in the early years of retirement, a period when they may be most active.
Where clients are looking to maintain their cashflow, there are a number of options and strategies that may help reduce the impact of the assets test changes. These could include:
- Increasing drawdowns from income streams and/or savings;
- Asset reduction strategies such as:
- Bringing forward any future gifts up to the allowable limits ($10,000 per financial year, $30,000 over five years);
- Bringing forward capital expenses or home renovations which may help reduce ongoing living expenses and/or increase comfort in retirement; and
- Investing up to $12,500 (per person) in a funeral bond or pre-paying funeral expenses (no limit).
- Investing a portion of capital in a lifetime annuity which can help meet ongoing cash flow needs and improve Age Pension entitlements over time.
Example
Matt and Lynn (both are age 68) own their home. They each have $450,000 in grandfathered ABPs (Matt and Lynn's deduction amounts are $25,338 and $21,676 respectively) that commenced two years ago.
Their only other assets are $10,000 in personal effects and $40,000 in the bank for liquidity purposes.
Their current Age Pension entitlement is $342.15 per fortnight ($8,896 per annum) and to achieve their required retirement income of $65,000 per annum, draw $28,052 per annum each from their ABPs.
If their assessable assets remain the same on 1 January 2017, their pension entitlement will reduce to nil.
The immediate and short-term outcomes
If Matt and Lynn were to increase their income payments from their ABPs, they will need to increase their annual pension payments from $28,052 to $32,500 each from 1 January, 2017. Matt and Lynn's pension entitlement will remain at $342.15 per fortnight for the remainder of 2016 and reduce to nil from 1 January, 2017.
Alternatively, if Matt and Lynn decide to reduce their assessable assets (using $50,000 each from their ABPs) by immediately gifting $10,000 to their grandkids, purchase a funeral bond worth $12,500 each and buy a new car for $65,000, their assessable assets will reduce by $50,000:
- $10,000 from the gift;
- $25,000 from the exempt funeral bonds; and
- $15,000 depreciation from a new car.
The reduction in assessable assets will provide an immediate increase in their Age Pension entitlement of $75 per fortnight to $417.15 per fortnight (increased from $342.15 per fortnight).
However, the reduction in assets is unlikely to prevent them from losing their Age Pension on 1 January, 2017. As such, over the next 12 months their total pension entitlement will likely be $2,503 (based on six remaining fortnights until 1 January, 2017).
This means Matt and Lynn will still be required to increase their income payments from their ABPs to $32,500 from 1 January, 2017 to maintain their cashflow.
Finally, if Matt and Lynn used 30 per cent of their ABP ($135,000 each) to commence a lifetime annuity, their assessable assets would reduce over time based on the annuity's reducing assessable asset value.
The annuity's assessable value will reduce each year by the deduction amount or by half the deduction amount every six months if income payments are at least semi-annually.
The deduction amount is calculated as the purchase price divided by their life expectancy and would equal (assuming no reversionary beneficiary is nominated):
- $8,017 for Matt ($135,000 / 16.84); and
- $6,930 for Lynn ($135,000 / 19.48).
As the annuity's first reduction does not occur until six months after it commences, Matt and Lynn's Age Pension entitlement will remain at $342.15 per fortnight until 1 January, 2017 where it will reduce to nil.
Based on six remaining fortnights in 2016, their total Age Pension entitlement over the next 12 months will likely be $2,053.
The table below summarises Matt and Lynn's Age Pension entitlements over the next 12 months under each scenario, including a case based on their current strategy and 1 January, 2017 assets test changes not occurring for comparison.
The longer term outcomes
From a longer term perspective, while the asset reduction strategies and lifetime annuity did not prevent Matt and Lynn from losing their pensions, it does help them achieve a higher pension outcome when compared to increased drawdowns from their ABPs, as illustrated in Chart 1.
Assumptions: Matt and Lynn's asset allocation is 50/50 growth defensive, with returns net of fees of 3.65 per cent on their defensive assets, and 6.25 per cent on growth assets. An additional platform fee/ongoing adviser service fee of 0.5 per cent per annum is also applied to their portfolio.
CPI is set at 2.5 per cent. Annuity scenario assumes Matt and Lynn maintain their overall asset allocation of 50/50 by increasing their remaining ABP's asset allocation to 71/29 growth/defensive.
Their lifetime annuity is based on Challenger's liquid lifetime annuity (regular income option) as at 20 September 2016 with a purchase price of $135,000 each, an upfront adviser fee of 2.2 per cent, monthly income payments of $6,750 each with no indexation and a 75 per cent withdrawal guarantee (Centrelink rates and thresholds as at 20 September, 2016).
In terms of the total Age Pension benefit received over the illustrated 15-year period, reducing their assets provided an additional $48,863 in Age Pension entitlements in today's dollars when compared to increased drawdowns from their ABPs.
However, as Matt and Lynn have spent $100,000 from their retirement capital early on, they will have less invested throughout the 15-year period. As such, their retirement capital is lower by $51,487 (in today's dollars) after 15 years.
Where the lifetime annuity strategy is implemented, Matt and Lynn receive an additional $36,067 in total Age Pension entitlements after 15 years when compared to increased drawdowns from their ABPs.
Unlike reducing assets (and assuming they maintain their overall asset allocation of 50/50 growth/defensive by increasing their remaining ABP's asset allocation to 71/29 respectively), Matt and Lynn's retirement capital has increased by $59,410 as the higher Age Pension entitlements each year meant less capital would be drawn from their ABPs, leaving more of their portfolio invested over the period.
Incorporating a lifetime annuity provided Matt and Lynn with a higher retirement portfolio value than the alternative strategies and helped to reduce the impact of the increased asset taper rate.
Summary
Cashflow is an important consideration for retirees, especially those in the earlier years of retirement. The rebalanced assets test on 1 January, 2017 may mean some of your clients are better off, while a number of clients could see a reduction, or loss, in their entitlements. This provides significant opportunities to discuss what the changes mean to your affected clients, and make any necessary adjustments to their retirement plans.
Minh Ly is the senior technical services analyst at Challenger.
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