With the rebalanced Assets Test in force, retirees can benefit from a review of their income drawdown strategies and identification of how the new Assets or Income Test ‘zones’ affect them.
Assets-tested clients may need to increase drawdowns from existing income streams to supplement their reduced Age Pension entitlements, or restructure existing income streams to improve entitlements over time.
In some cases, clients may have moved from the Assets Test zone to the Income Test zone where strategies to reduce assessable income can add significant value.
In this article we focus on those in the Income Test zone and use a case study to illustrate strategies that may assist them.
Income Test zone
Given the importance the Age Pension can have in helping retirees achieve their required cash flow during retirement, a regular review of whether entitlements are assessed under the Assets or Income Test may be worthwhile. The effectiveness of strategies may change depending on the test that applies.
For singles, the Income Test starts to apply when financial assets reach $153,908.
Income Test strategies continue to be relevant until financial assets reach $275,500 for homeowners and $528,000 for non-homeowners (see Table 1 and Chart 1). From this point, the Assets Test will determine Age Pension entitlements.
Once financial assets reach $526,000 (homeowners) and $726,000 (non-homeowner), Age Pension entitlements reduce to a minimum amount of $49.10 per fortnight (made up of the $14.10 energy supplement and $35 minimum Age Pension supplement) before cutting out entirely when assets reach $542,500 (homeowners) and $742,500 (non-homeowners).
Chart 1: Income Test ranges and Age Pension entitlements for singles
Assumes assets held are financial and deemed under the Income Test.
For couples, the Income Test starts to apply when financial investments reach $271,262, as illustrated in Chart 2. Income Test strategies continue to be relevant until financial investments reach $402,500 for homeowners and $655,000 for non-homeowners.
For homeowners, eligible members of a couple, who are not separated by illness, will receive a minimum amount of $37 per fortnight per person (made up of $10.60 energy supplement and $26.40 minimum Age Pension supplement) where assets are between $791,500 and $816,000. For non-homeowners, the asset range to receive these supplements is $991,500 up to $1,016,000.
Chart 2: Income Test ranges and Age Pension entitlements for couples
Assumes assets held are financial and deemed under the Income Test.
Table 1: Income Test zone summary
||Income Test zone (asset range)
||$153,908 up to $275,500
||$153,908 up to $528,000
||$271,262 up to $402,500
||$271,262 up to $655,000
The Income Test zones do not remain static and can change over time with certain variables. These variables include indexation of the Assets Test thresholds and any changes to the Assets Test taper rate, deeming thresholds and deeming rates in the future.
For example, the Income Test zone for couple homeowners would widen from $271,262 and $402,500 (based on current deeming rates of 1.75% and 3.25% and deeming threshold of $81,600) to $251,886 and $411,000 (based on 2% and 3.5% and deeming threshold of $81,600). Conversely, if deeming rates decreased, the income zones shrink in both directions.
Opportunities for income-tested clients
For income-tested clients, strategies that help reduce social security assessable income can provide an immediate improvement in Age Pension entitlements. Strategies could include restructuring their current cash flow approach and/or reviewing current investments, as explained in the following case study.
Case study – James and Beth
James and Beth are both 68 and have $170,000 each in deemed account-based pensions (ABPs). They own their home and have $30,0001 in the bank. Their car and other home contents are worth $15,000. They have a cash flow requirement of $52,000 p.a. This is met by drawing $18,322 p.a. from their ABPs, and $32,778 from the Age Pension and investment earnings.
James and Beth could consider these two strategies:
1.Maintain current drawdowns
By maintaining their current retirement income strategy, James and Beth will continue to meet their cash flow requirements. As their financial assets reduce over time, their assessable income will also reduce, increasing their Age Pension entitlements, as shown in Chart 3 (blue line). However, in this scenario, they will only achieve the full Age Pension from year nine onwards.
Chart 3. James and Beth’s projected Age Pension entitlement (today’s dollars) – current income strategy compared with a 30% allocation from their ABPs to a lifetime annuity.2
2. Use a long term annuity
James and Beth could boost their Age Pension entitlements and achieve a higher level of secure income over the longer term by using a long term annuity.
Long term annuities can help reduce assessable income as they are afforded beneficial social security treatment that can generate an immediate increase in pension entitlement for income-tested clients.
For example, if they allocate 30% of their ABPs to purchase a lifetime annuity , they could reduce their assessable income by $3,315 in year one. This would increase their Age Pension immediately to $1,292.40 per fortnight ($33,602 p.a.) as shown by the green line in Chart 3. The lifetime annuity strategy results in additional Age Pension entitlements of $6,584 ($6,182 today’s dollars) over 15 years, providing uplift in their retirement income. James and Beth also achieve full Age Pension from year two onwards.
With a higher Age Pension entitlement allowing them to reduce the amount they draw from their ABPs, it would also leave more of their retirement capital invested over the15-year period. At the end of 15 years, they would achieve an additional $25,537 ($17,632 today’s dollars) in their retirement portfolio as illustrated in Chart 3.
The rebalanced Assets Test provides an opportunity to review income drawdown strategies and identify where clients fall under the new Assets and Income Test zones. Where clients are income tested, strategies to reduce assessable income are a priority and a number of cash flow solutions may be implemented to improve Age Pension outcomes.
Whichever cash flow solution is implemented, there will be different outcomes for different clients, and professionals are well placed to guide clients through this process.
1Earning 3% p.a.
2Challenger Age Pension calculator. Based on James and Beth’s asset allocation of 50/50 growth/defensive, returns net of fees of 3.65% on defensive assets, 6.20% on growth. An additional platform fee/ongoing adviser service fee of 0.50% p.a. is also applied to their ABP portfolio. CPI of 2.5%. Annuity scenario assumes James and Beth 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 04/01/2017 with a purchase price of $51,000 each, an upfront adviser fee of 2.20%, monthly income payments of $212.50 each with no indexation and a 75% withdrawal guarantee. Centrelink rates and thresholds as at 01/01/2017.