Navigating the latest round of asset test changes for your clients
Mark Teale looks at what challenges the new assets test for the Age Pension will have for advisers and clients.
The assets test for the Age Pension received quite the dramatic New Year makeover — with changes coming into effect as of 1 January 2017.
Now, the assets test thresholds have increased — meaning a number of pensioners have witnessed an increase in their entitlements. However, the doubling of the ‘taper rate' has certainly ruffled quite a few industry feathers.
But what will this mean for our clients?
For every $1,000 in assessable assets above the threshold limits, a pension entitlement is reduced by $3.00 per fortnight. Prior to 1 January 2017, this reduction in pension was previously $1.50 per fortnight for every $1,000 in excess of the threshold.
The table below provides a good indication of the effect of these changes.
The mainstream media and various political parties over the last month have all had their say concerning the harsh effect these changes will have on the lifestyles of pensioners. The reaction would appear to be a little like that old saying, "shutting the gate after the horse has bolted".
The changes — announced in the government's 2015 Budget — were passed by Parliament over 15 months ago.
As an industry we need to be very careful to not get caught up in the negative rhetoric, while still remaining mindful of the ramifications ahead for clients.
Do not be rushed into quick decisions to ensure your client retains or qualifies for the Age Pension under these new rules.
Example 1
A single homeowner age pensioner with assets (excluding their home) of $560,000.
Prior to the changes they would have been entitled to an Age Pension of $350.60 per fortnight, or $9,115.60 per annum. However, following this change, their entitlement is now reduced to zero.
To ensure that the pensioner again qualifies for Age Pension they could gift $10,000 and purchase a funeral bond for $12,500, and thereby reduce their total assets to $537,500. The pensioner would now qualify for the minimum Age Pension of $35 per fortnight (or $910 per annum).
The minimum Age Pension is the amount of the pension that is paid before a person's entitlement is reduced to zero.
So the question I would ask is this: "Is it worthwhile for this retiree to reduce the cash they have invested ($22,500) in order to qualify for a pension of $910 per annum?"
There is no doubt their lifestyle has been dramatically affected by the legislated changes to the assets test. However, by ensuring they remain qualified for an Age Pension of $910 per annum — spending $22,500 could be a little short sighted.
Even with their pension entitlement restored there is still an $8,205 per annum cash shortfall. No doubt this shortfall will need to be made up by drawing down on the capital a person has invested, which is now $22,500 less.
What are the options for a person whose assets do not provide an ability to drawdown the necessary income to make up the shortfall? For example, a real estate asset which is not producing a return at this moment in time?
The short answer is of course to sell the asset, but that is not always possible.
Another option that very few people consider is an equity release loan administered by the government called the Pension Loans Scheme (PLS).
The pension loans scheme
In 1985, following the reintroduction of the assets test for Age Pension purposes, the government introduced the PLS which was designed to assist those people whose Age Pension reduced as a result of the reintroduction of the assets test.
With the January 2017 changes to the assets test having now been applied, and the potential for many recipients of the Age Pension to suffer a reduction in — or complete loss — of their Age Pension, the PLS is worth considering as an option for affected pensioners to better manage their income needs.
To be eligible to access the PLS an applicant must meet the following requirements:
- Be of Age Pension age, or the partner of someone who is;
- Be receiving and/or qualified to receive:
- Age Pension
- Disability support pension
- Wife pension
- Carer payment
- Widow B pension
- Bereavement allowance
- Own real estate in Australia of sufficient value to secure the payment of any debt that may become payable.
To clarify the second point an applicant must either be in receipt of a part-pension, or have been disqualified from receiving a pension because of the assets test or the income test — but not be disqualified under both tests.
When a loan is granted under the PLS the borrowed amount is paid by way of fortnightly income instalments. The scheme does not provide lump sum loans.
The maximum amount that is payable under the PLS is the difference between the maximum rate of Age Pension, plus pension supplement, and where applicable rent assistance, and the amount of Age Pension actually being paid.
When an individual or couple is receiving no Age Pension because of the application of either the assets test or the income test, then the maximum loan payment that can be made in that instance is the maximum rate of Age Pension.
The costs associated with establishing a loan under the PLS are paid by the applicant. They may also be deducted from the loan.
Loans made under the PLS are secured by real estate owned in Australia. The loan is secured by way of a statutory charge over the property. In essence, the Commonwealth lodges a caveat over the property (or in Queensland, a ‘notice of charge'). Costs associated with registering and removing the charge are payable by the loan recipient.
Payments of the amount borrowed are paid fortnightly and interest compounds based on the amount of the loan are outstanding each fortnight.
The current rate of interest applied to the PLS is 5.25 per cent. This rate of interest has remained current since 25 December 1997. The interest rate may vary slightly at the discretion of the Minister for Social Services.
The current rate of interest is favourable when considering the current market interest rate for reverse mortgages vary from 6.25 to 6.74 per cent.
An outstanding loan is repaid by the following means:
- Whenever the borrower chooses;
- When a sale of the property used as security occurs; or
- When the recipient is deceased.
Where a loan recipient has passed away, the loan will generally be repaid by their estate.
The maximum amount that can be borrowed under the PLS is set by a formula that references an ‘age component amount' set out in section 1135A of the Social Security Act (1991), and the value of the property being offered as security, less any ‘nominated guarantee amount'.
The value of the real estate assets being used to secure the loan is rounded down to the nearest multiple of $10,000. That is, a property valued at $387,500 would be rounded down to $380,000 when applying the formula.
The formula for determining the maximum amount of loan that will be available is:
When determining the value of the real estate being offered as security, the property must be valued. The valuation is generally carried out by a valuer appointed by Centrelink, at no cost to the applicant.
The value of a property, for purposes of determining the maximum loan that can be made, may not be the full value of the property.
The value, for purposes of determining the maximum loan, may be reduced by the amount of any outstanding mortgage on the property, and by any nominated guarantee amount.
A nominated guarantee amount is an amount, nominated by the applicant, set aside for other purposes.
For example, an applicant may intend that $150,000 from the eventual proceeds of the sale of a property be paid to a beneficiary of their estate. Where a guarantee amount is nominated, that amount is deducted from the value of the property for the purpose of calculating the maximum loan amount.
The table below shows the age component amount depending on a person's age.
In the case of a couple, the age of the younger member of the couple is used for purposes of applying the age component amount. However, if only one member of a couple is applying for a loan under the PLS then that person's age is the one applied.
Example 2
A single woman aged 72, who owns a home valued at $750,000. She has lost her pension because of the asset value of monies she has loaned to her children. She would like to nominate a guaranteed amount of $250,000.
She is able to borrow $166,500 as shown by the following formula:
Remember this is the capped loan amount based on the maximum pension being paid on a fortnightly basis.
If the individual in this case had not nominated a guaranteed amount of $250,000 — then her capped borrowings would have been $249,750.
Where a loan has been granted under the PLS the maximum loan value is reviewed every 12 months as part of the annual pension review.
Do your homework
I believe before a retiree considers this option that all the necessary beneficiaries of an estate should be very much aware of the loan, and the possible effect it may have on any future inheritance.
The Pension Concession Card (PCC) would not be issued to the person or couple who is being paid the maximum rate of pension under the PLS. To receive the PCC an entitlement needs to be established under either the income or the assets test.
The PLS may not be for everyone but for some pensioners, those who have lost their entitlement because of the changes to the assets test, it could be a worthwhile option.
Facing reality
I have one final point when looking at clients whose circumstances have been affected by the changes to the assets test. We must remember that a large percentage of these people as they age, and their health declines, will be confronted by the realities of residential aged care.
Leaving a client with limited assets or cash to ensure they retain some part of the Age Pension may also limit the choices available to them when looking for a suitable aged care facility.
The funding issues associated with aged care are complicated, and the fees that need to be paid are based on the Centrelink assessment of assets, and income as per the Age Pension.
However, there is one very important difference which we do need to be mindful of. I believe that a number of those retirees who have lost their entitlement to Age Pension will requalify for an Age Pension after entering residential aged care, and paying a refundable accommodation deposit (RAD).
The RAD is not an asset for the purposes of calculating a person's Age Pension entitlement.
So, as an example, let us revisit our original single homeowner who had assets of $560,000 and has lost their pension.
If they were to enter residential aged care and pay a RAD of $350,000 leaving them with assets of $210,000 — they could possibly qualify depending on the income generated from the $210,000 for a full Age Pension of $877.10 per fortnight.
Of course, after two years their home would become an assessable asset, and no doubt they would once again lose their pension entitlement.
The change in assets test on 1 January 2017 reaffirms that for those age pensioners who have seen their pension reduced, or have lost their entitlement completely, a knowledgeable adviser is extremely important and an essential support when it comes to having to deal with the complexities of the Social Security Act.
Be knowledgeable and make sure you stay up to date with the curve balls thrown our industry's way.
Mark Teale is a retirement strategies and solutions specialist at Centrepoint Alliance.
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