Talking retirement and pension strategies

Retired actuary and author John De Ravin knows our retirement income system can be complex and, to help, has written a book of financial strategies, including chapters for pre-retirees and retirees. In this extract from Slow and Steady: 100 wealth building strategies for all ages, he outlines the strategies that can determine whether you could qualify for a full or part Age Pension.

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Strategy 78: Give it away!

Read this strategy if:

  • you are approaching Age Pension eligibility age (but ideally have at least five years to go)
  • you expect to receive a part Age Pension (that is, your assets are neither so high as to preclude you from receiving any Age Pension, nor so low that you expect to receive the full Age Pension)
  • you will not have much earned income in retirement and you expect your part pension to be determined by the result of the assets test rather than the income test
  • you would like to find ways of increasing the amount of Age Pension you will receive.

Background

In Australia, when you reach Age Pension age, if you are eligible for the pension then you can apply but the amount of pension to which you are entitled is subject to means testing.  Currently, the means testing comprises:

  • an assets test
  • an income test.

Age Pension payments are subject to a maximum amount payable for a single pensioner and a (higher) maximum amount for a couple. The maximum amount payable increases by a “rental assistance” amount if you do not own your own home. Each of the two tests is applied to determine the amount of pension you are entitled to receive according to that test, and the pension to which you are finally entitled is the lower of the amounts that result from applying the assets test and the income test.

In most cases, unless you are earning significant income from your personal efforts (as distinct from income from financial assets), it is the assets test that will determine how much Age Pension you will receive.

With effect from 1 January 2017, the Age Pension ‘taper rate’ due to the impact of the assets test has changed, as well as the lower and upper thresholds of the assets test.  The taper rate used to be $1.50 per fortnight of pension per $1000 of assets held in excess of the lower assets test threshold, but from 1 January 2017 the taper rate increased to $3 per fortnight of pension for every $1000 of assets held in excess of the lower assets test threshold. However your home remains exempt (at least for the time being) from the assets test.

But the $3 per fortnight amounts to a little over $78 per year, which means that for every $1000 you hold in assets in excess of the lower assets test threshold, you will lose 7.8 per cent of that excess amount in annual Age Pension.

But interest rates are currently extremely low in Australia (and around the world).  Typical bank savings accounts pay less than 1% interest and 10-year Australian government bonds also yield less than 1% per annum.  What this means is that if you have (say) $100,000 in assets above the lower assets test threshold, and you invest it in bank deposits or Australian government bonds, you may earn $1000 on your money, but if you throw your $100,000 out the window, you will get an additional $7800 in Age Pension, indexed, for the rest of your life (or at least as long as your asset balance would have continued to exceed the lower assets test threshold by $100,000).

Of course, apart from the $1000 that you could earn in income on that additional $100,000, you could use some of it to supplement your lifestyle, so that you could use some capital to increase your consumption to the same $7800 as you would have received had you been receiving the full pension. But if you invest your funds conservatively (as many retirees do) then your invested money will not last your lifetime if you want to draw down 7.8 per cent every year.

In fact, it can be shown that if you spend down your funds prudently, with the objective of producing a stable and consistent level of consumption over your lifetimes, and if you invest cautiously (for example, in bank accounts), then the ‘effective tax rate’ that applies to assets held in excess of the lower threshold of the assets test is more than 100 per cent! In other words, what you lose in Age Pension payments as a result of having that extra money is more than the extra money itself!

This means that there is a significant incentive, for those who expect their assets in retirement to be between the lower and upper thresholds for the assets test, to dissipate assets in excess of the lower threshold in order to gain additional pension.

Of course, you might question whether it is good public policy for the government to apply a taper rate so penal that it’s better for a retiree not to have the additional funds.

Key point
It is well known to financial planners and to astute financial commentators such as Daryl Dixon that those who expect the assets test to determine their Age Pension amount, and who expect their assets to fall between the lower and upper assets test thresholds, will find it attractive to consider ways of reducing their asset base for assets test purposes to secure higher Age Pension payments.

There are a number of ways in which you can do this:

1.         Sell your existing home and buy a more expensive one. This works from an assets test point of view because your own home is exempt from the assets test. 

2.         Renovate your existing home. Again, any increase in value of your existing home falls outside the assets test because your home itself is not asset testable.

3.         Prepay your funeral. This avoids having to pay the expenses of your funeral from your estate, and a prepaid funeral does not count as an asset for asset testing purposes.

4.         Spend it! You can take a long and expensive holiday or throw the party of a lifetime!

5.         Give it away! Just plain give away your money – maybe to charity, maybe to friends, but more likely to those relatives who would be likely to be your beneficiaries when you pass away anyway.

It may seem strange given that so many of the strategies in this book are designed to increase the assets you have as you approach retirement, but this strategy is aimed at reducing your assets.

How to do it
You need to decide which of the above five strategies for reducing your asset-tested assets appeals to you.

1.         Sell your existing home and buy a more expensive one. Of course, selling a home and buying another one does involve a significant level of expense, perhaps of the order of 10 per cent of the selling price of your existing home, and these expenses have to be factored into your assessment of whether this strategy will help you end up with the home you want and the level of asset testable assets you want. This is more likely to be a viable option if, for some reason, you were in any case considering moving house at around the time you reach Age Pension age, perhaps because you want to downsize your home, or because you want to live in a different neighbourhood, or because you want to move closer to your own ageing parents, or for some other reason.

2.         Renovate your existing home. Again, any increase in value of your existing home falls outside the assets test because your home itself is not asset testable. This is a good option if you can think of something that really needs doing, which will make your life more enjoyable.

3.         Prepay your funeral. As long as you have a contract that says you’ve paid in full for your funeral, the amount paid to a funeral director is not counted as part of your assessable assets. (You can also use funeral bonds to pay for your funeral but the amount you can invest in these is limited to an ‘allowable limit’, currently $13,500 as of 1 July 2020. This amount is indexed every year on 1 July.)

4.         Spend it! 

5.         Give it away! For asset testing purposes, you can only give away assets up to a certain amount ($10,000) each year, and can only give away $30,000 in any five-year period. Any additional assets that you give away will be treated as ‘deprived assets’ and the excess over the amount permitted by the gifting rules will still be included as assets for asset testing purposes for five years after you make the gifts. So ideally, you need to consider this strategy five years before you become eligible for the Age Pension. If your eligibility age is 67, that means you need to think about gifting some of your assets before you turn 62.

What does it mean for you financially?
Because the assets test “tapers” your Age Pension entitlement at $3 per fortnight for every $1000 of assets you have in excess of the lower assets test threshold, effectively, for every $1000 that you manage to dispose of (other than by giving it away in excess of the gifting rules within five years), you get a return of 7.8 per cent on the money that you now don’t have. There are a little over 26 fortnights in a year so you will get an additional $78 of Age Pension income per $1000 that you get rid of. What is more, the income is paid by the Australian government and it is indexed half-yearly. By comparison, if you invested money ‘safely’ in a term deposit with a bank or in a cash account, you would probably get only about $10 of income from your money (though it is fair to say of course that you would still have the $1000 to draw down on whenever you wanted it). 

The stringency of the assets test also has implications for those who are not yet retired, but who expect their assets at retirement (other than their own home) to fall between the lower assets test threshold and the upper assets test threshold. 

The table below shows the lower assets test thresholds, with effect from 20 July 2020, from the Services Australia website:

If you’re                                              Homeowners   Non-homeowners

Single                                                  $268,000         $482,500

In a couple, combined                         $401,500         $616,000

Illness-separated couple, combined    $401,500         $616,000

One partner eligible, combined          $401,500         $616,000

The upper assets test thresholds, with effect from 20 July 2020:

If you’re                                              Homeowners   Non-homeowners

Single                                                  $583,000         $797,500

In a couple, combined                         $876,500         $1,091,000

Illness-separated couple, combined    $1,031,500      $1,246,000

One partner eligible, combined          $876,500         $1,091,00

Because the current asset testing taper rate is so penal relative to the income you can earn from investing the funds conservatively, it isn’t worth making much effort to get into the asset testing range unless you are aiming to achieve assets at retirement that are comfortably above the top end of the asset testing range.

Factors to take into account before you decide
It is important to note that this strategy does not apply to those whose assets will fall short of the lower assets test threshold (since these people will always receive the full Age Pension anyway) and also does not apply to those whose assets will comfortably exceed the upper assets test threshold (since these people will be self-funded anyway, and will not receive any Age Pension unless perhaps after a number of years they find that their assets have fallen below the upper threshold so that they can start to receive a part Age Pension).

The reasoning above in relation to it being better to give your money (in excess of the lower Age Pension asset threshold) away by the time you hit Age Pension age applies to those who are commencing the pension but not necessarily to those who are already older. For example, someone aged 85 or 90, even if their assets were between the lower and upper thresholds, would be better off by spending down their assets at a reasonable rate (perhaps 7 per cent to 10 per cent of their assets) to support their lifestyle rather than aiming to spend down a large amount of assets to get more pension.

There is very little risk that the Australian government will default on its pension payments. However, there is a significant risk that the government will change the Age Pension means testing arrangements. For example, a significant change in those arrangements commenced on 1 January 2017, and many part age pensioners lost their part entitlement as of that date. So there is a risk that if you somehow ‘dispose’ of some of your assets in excess of the lower threshold, you may not get the full amount of the additional pension that you were expecting in future years – for example, if the government again tightens the means testing requirements.

If you are not yet retired but are trying to decide how fiercely to save for retirement, it is important to identify where you fit into the asset testing range. If you will more or less inevitably fall short of the lower assets test threshold, then any additional moneys that you accumulate will be yours and it will be worth the effort to save those additional funds to build up your asset base for retirement. Saving will increase your lifestyle in retirement.

Also, if you expect to be well above the upper assets test threshold, you will be a ‘self-funded retiree’ and again, whatever you can do to increase your assets will flow directly through to your assets in retirement and therefore to your retirement lifestyle.

However if you are ‘in the middle’ and expect to be receiving a part Age Pension (along with a high percentage of Australian pre-retirees), then some of those additional savings will benefit the government rather than you (by reducing its obligation to pay you the part Age Pension).

This means that it becomes important to form a view as to whether at retirement your assets will be:

1.         comfortably above the upper assets test threshold

2.         between the lower and upper thresholds, or only very marginally above the upper threshold

3.         below the lower assets test threshold.

Also, the choice to rapidly spend down assets to get more Age Pension has implications for your bequest under your will when you pass away. Obviously if you spend assets quickly when you are a young retiree, that will deplete assets compared with the situation where you conserve your assets and spend down only slowly and steadily in retirement. The ‘spend fast while young’ strategy can benefit your current income and consumption but will tend to leave a smaller estate. So before adopting such a strategy you might consider the strength of your bequest motive. If you have a strong desire to leave the largest possible inheritance to your beneficiaries, then you might spend money on a renovation or on upgrading your home (as these will be valuable assets when you pass away despite being outside the assets test) but you wouldn’t hold the party of a lifetime and invite 500 guests, nor would you throw your money away!

One final reason why you might decide not to ‘throw it away’ is that some future government might identify that the very high assets test taper rate is discouraging people from saving where their assets at retirement are likely to fall within the part Age Pension assets test range. In that case, the government might decide to reduce the assets test taper rate – but that may mean expanding the range of the assets test, perhaps by reducing the lower threshold again and increasing the upper threshold. In that case, the rationale for having divested yourself some of your assets might, at some future date, disappear – after you have already taken action to get rid of those assets! Unknown future changes to the Age Pension means testing rules make financial planning for retirement difficult for pre-retirees who expect to receive a part pension and for retirees who do currently receive a part Age Pension .

Are you likely to seek financial advice to determine your best approach? Will you follow strategies that will allow to qualify for a full or part Age Pension? Were you a ‘victim’ of the taper rate change in 2017?

Slow and Steady is available from John De Ravin’s website for $39.95.

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Written by John De Ravin

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