Important and at times complex, considerations when providing retirement income advice are the Social Security means testing rules.
Professionals are not only tasked with understanding how different assets and income streams are assessed, but also how different transactions, strategies and changes in a client’s circumstances interact with the means tests.
To help navigate some of the complexities, we discuss below some common means testing queries.
1. Will partially commuting a ‘grandfathered’ account-based pension result in the loss of its grandfathered status?
The first requirement for existing account-based pensions to be grandfathered is it must have commenced prior to 1 January 2015. Transactions that do not impact the income stream’s commencement date, such as pension payments and partial lump sum commutations, will not impact its grandfathered status.
The second requirement is the person must have been in continuous receipt of an income support payment since 1 January 2015.
Where a person makes a partial lump sum commutation, grandfathering could be lost if, after the commutation, the person loses their income support payment. This can occur if assessable income from the account-based pension increases due to the recalculation of its deduction amount or where deemed income increases from the investment of withdrawn amounts.
The Department of Social Services’ Guide to Social Security Law provides that ’a person is considered to be in continuous receipt of an income support payment where they receive at least $0.01 of income support in each consecutive fortnight from 1 January 2015.’
Immediately moving from one income support payment to another, for example from the Carer Payment to the Age Pension, will continue to meet the requirement of being in continuous receipt of an income support payment.
2. How will a partial lump sum commutation from a grandfathered account-based pension affect its deduction amount?
A partial lump sum commutation from a grandfathered account-based pension will cause its deduction amount to be recalculated (and reduced) based on the following formula:
Deduction amount = (Purchase price less commutations) / relevant number
The relevant number is the life expectancy of the person (or the longest life expectancy where a reversionary was nominated) at the commencement of the account-based pension. It does not change when recalculating the deduction amount.
Importantly, although the deduction amount is recalculated, the account-based pension’s minimum income amount for the year remains the same and does not get recalculated until 1 July.
A partial lump sum commutation from a grandfathered account-based pension will cause its deduction amount to be recalculated.
An account-based pension commenced in 2006 with $350,000 (relevant number of 21.15) has a deduction amount of $16,548 ($350,000 / 21.15).
On 1 July 2018 the grandfathered account-based pension has an account balance of $280,000 and income payments of $16,800 p.a. (minimum required for the 2018/19 year). Social Security assessed income amounts to $252 ($16,800 - $16,548).
If a partial lump sum commutation of $50,000 is made on 1 September 2018, the deduction amount would be recalculated to be $14,184 ([$350,000 - $50,000] / 21.15). Social Security assessed income would increase to an annualised amount of $2,616 ($16,800 - $14,184) for the remainder of 2018/19.
3. If my client gifts $30,000 in one year, does the $20,000 held as a deprived asset reduce gradually to nil over the next two years?
While the gifting rules allow gifts of $10,000 per financial year and a maximum amount of $30,000 over a rolling five financial year period, amounts that exceed these limits are treated as deprived assets. Deprived assets are maintained as a person’s asset (and subject to deeming under the Income Test) for five years from the date of the gift.
Additionally, a person cannot ‘bring forward’ the annual limits and access the $30,000 limit in one year.
Where a person gifts $30,000 in one year, $20,000 is held as a deprived asset for five years. However, amounts held as a deprived asset does not count towards a person’s annual gifting limit in the following year or their rolling five-year limit of $30,000.
This means they can gift up to $10,000 in the second year and up to another $10,000 in the third year without increasing the amount held as a deprived asset. These limits apply to both singles and couples combined meaning couples do not have the benefit of accessing two times these limits.
The gifting rules allow gifts of $10,000 per financial year and a maximum amount of $30,000 over a rolling five financial year period.
However, where the deprived asset related to a gift of an asset that was only owned by one member of a couple and that person dies, the deprived asset is no longer assessed against the surviving partner as the original asset was not owned by them.
4. What are the Centrelink implications if my client withdraws their whole of life/endowment insurance policies?
During the term of whole of life and endowment policies, their surrender or withdrawal value is assessed under the Assets Test and is reduced by any debt against the policy. There is no income assessed.
On withdrawal (or maturity) of the policy the ‘profit’ (difference between the surrender/withdrawal value and the sum of the person’s contributions/premiums towards the policy) is assessed as income over 12 months.
Additionally, depending on how the proceeds are invested, there may be a further assessment under the Income and Assets Tests. For example, if the proceeds are invested in a term deposit, the value of the term deposit will be assessed under the Assets Test and deemed income assessed under the Income Test.
5. How much of a client’s defined benefit income is assessed under the Social Security Income Test?
A defined benefit income stream for Social Secuirty purposes is a pension paid from a public sector or other corporate defined benefit superannuation fund or superannuation scheme (e.g. the Public Sector Superannuation Scheme). It does not include income streams purchased from retail providers, or income streams provided from self-managed superannuation funds and small APRA funds.
The Income Test assessment of defined benefit income streams is calculated as:
Annual payment less deductible amount
The deductible amount is the tax-free component of the regular payments. As the tax-free component is a fixed portion of the regular payments, it will increase as payments increase (from indexation).
However, since 1 January 2016 the deductible amount is capped at 10% of the annual income payment (the 10% cap). Importantly, while there were no grandfathering provisions for defined benefit income streams that existed prior, there were exceptions.
Defined benefit income streams paid by the following military superannuation funds are not subject to the 10% cap:
- Defence Force Retirement and Death Benefits Scheme (DFRDBS)
- Defence Force Retirement Benefits Scheme (DFRBS)
Additionally, the 10% cap does not apply to the Income Test of pensions paid by the Department of Veteran Affairs (DVA), for example the Service Pension.
6. Can capital depreciation and interest payments reduce the amount of assessable rental income for Social Security purposes?
Rental income is generally assessed for Social Security purposes in the same way it is assessed for tax purposes with some exceptions.
One of these exceptions is capital depreciation. While allowable as a deduction for tax purposes, capital depreciation on real estate doesn’t reduce assessable income for Social Security. The Department of Social Services’ Guide to Social Security Law provides other exceptions including:
- special building write off,
- construction costs,
- borrowing costs, e.g. loan establishment fees.
Additionally, if net income is negative, it is taken to be nil for Social Security and cannot offset other assessable income.
Interest payments can reduce assessable income for Social Security if the purpose of the loan was to purchase a rental property.
A person who was living on their own takes out a loan, secured against their principal place of residence, to pay a lump sum accommodation payment for a place at an aged care facility.
Any assessable value of the home can be reduced by the loan secured against it. If the person decides to rent out their former home, any assessable rental income will not be reduced by interest payments on the loan as the primary purpose of the loan was not to purchase a rental property.
7. Does salary sacrificing employment income into superannuation reduce my client’s assessable income for their Age Pension?
Amounts salary sacrificed into superannuation are assessed as income.
Where the employee makes a personal deductible contribution to super instead, this is not assessed as income. However, their gross employment income before it is reduced by their deductible contributions is assessed as income.
8. How is a client’s granny flat interest assessed if they enter a residential aged care facility?
Generally when a person enters a residential aged care home, their granny flat arrangement ceases and the person becomes a non-homeowner.
For members of a couple where their spouse remains in the granny flat home, the home ownership status remains the same as the home ownership status prior to the person entering residential aged care. Non-homeowner couples will continue to have the amount paid for their granny flat arrangement assessed under the pension Assets Test. The amount paid will also be assessed for aged care means testing.
For single non-homeowners where their granny flat arrangement ends on entering residential aged care, the amount paid for their granny flat arrangement will no longer be assessed.
Note that where a person stops living in a granny flat interest less than five years after the time the interest was created, the deprivation rules may apply if the reason they left could have been anticipated.
As there is no clear definition of what constitutes an unforeseeable event, Centrelink will assess each case individually.
9. How are annuities purchased today assessed under the Centrelink/DVA Income and Assets Tests?
The assessment of annuities that are not Assets Test Exempt depends on whether they are classified as a long-term or a short-term annuity.
Long-term annuities include lifetime annuities and annuities that pay regular income for a term of more than five years. It also includes terms of five years or less if the term is equal to or greater than the person’s life expectancy.
Short-term annuities generally pay regular payments for a term of five years or less and are not classified as long-term as above.
The assessment of long-term and short-term annuities are summarised in the following table:
|Annuity type||Assets test||Income test|
|Long-term||Purchase price less (DA x term elapsed)||Payment amount less DA|
|Short-term||Purchase price less (DA x term elapsed)||Deeming based on assessed asset value|
DA = (Purchase price less residual capital value) / relevant number
- The purchase price of the annuity is net of any lump sum commutations.
- The term elapsed is the number of years elapsed since the commencement day rounded down to the nearest half-year. Asset valuations are done every six months, or every 12 months if regular payments are taken annually.
- DA is the deduction amount of the annuity and
- for lifetime annuities, the residual capital value is nil and the relevant number is the person’s life expectancy at commencement. Where a lifetime annuity has a reversionary or is held jointly, the longest life expectancy is used.
- for fixed term annuities, the relevant number is the term of the annuity.
The Government has proposed new means testing rules for lifetime annuities purchased from 1 July 2019. Lifetime annuities purchases prior to 1 July 2019 will continue to be assessed under current rules.
10. How are annuities assessed under the Commonwealth Seniors Health Card (CSHC) Income Test?
Annuities are nonacount-based income streams and as such are not subject to deeming under the CSHC’s Income Test.
Since 1 January 2015, the CSHC Income Test assesses both a person’s adjusted taxable income1 (ATI) and deemed income from account-based income streams (e.g. accountbased pensions) that are not grandfathered.
Annuities are non-account-based income streams and as such are not subject to deeming under the CSHC’s Income Test.
Income from superannuation lifetime or term annuities paid to those aged 60 and above are tax-free and are excluded from the person’s overall ATI. Where the person is less than 60, only the taxable portion of the income is assessable and included in their ATI.
Non-superannuation annuities on the other hand, continue to have a deductible amount calculated and only the payment in excess of this amount is included in the person’s ATI.
An annuity’s deductible amount for tax purposes is calculated as:
Purchase price less residual capital value (RCV) / relevant number
For lifetime annuities, the residual capital value is nil and the relevant number is the life expectancy of the person (or the longest life expectancy where there is a reversionary or if the annuity is held jointly) at commencement.
For fixed term annuities the relevant number is the nominated term at commencement.
Where a partial commutation has occurred, the annuity’s deductible amount is recalculated based on the amount of the commutation and deductible amounts that have been used in prior years.