Quantifying the impact of assets test changes on your retirement
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With the 1 January 2017 assets test changes now in effect, it is important retirees who may be over the new assets test cut-off understand the implications on their age pension entitlements.
It is also important for all retirees to review their spending plans in light of how these changes impact their retirement over the longer term.
A recap of what is changing
The rebalanced pension assets test on 1 January 2017 will:
1) Have higher assets test thresholds (Table 1), and
2) Double the taper rate from $1.50 to $3 per fortnight per $1,000 of assets.
1) Higher assets test thresholds
The first of the changes is an increase in the assets test thresholds. This allows retirees to hold more assets before their pension starts to reduce under the assets test.
For some retirees with lower asset levels, this may lead to higher pension entitlements. For others, the income test will continue to determine their entitlements.
Table 1: Assets Test thresholds
2) Increasing the assets test taper rate
The second change is an increase in the taper rate. This change reduces 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 2). Pensioners with assessable assets above the new cut-off will see their pensions reduce to nil.
Table 2: Assets Test cut-off thresholds
Case study: quantifying the impact on your retirement
Bruce, aged 68, and his wife Anne, aged 66, run their own self-managed super fund (SMSF).
In November 2016, they have $20,000 in personal assets, they own their home and have $750,000 in total household savings they are using to fund their retirement:
- $650,000 in account-based pensions (ABPs) ($400,000 in an ABP for Bruce and $250,000 in an ABP for Anne both assumed to have commenced after 1 January 2015) in their SMSF in a broadly balanced asset mix
- $30,000 in cash outside super and $70,000 invested in a share portfolio.
They currently plan to spend $58,000 per annum in retirement increasing with inflation to maintain their standard of living, and they also estimate their spending needs will reduce by 30 per cent when the first of them passes away.
Under the age pension rules prior to 1 January 2017, Bruce and Anne were receiving an age pension entitlement of $612.15 per fortnight.
Their entitlement is being determined under the assets test and post 1 January 2017 their age pension entitlement is expected to reduce by $474.75 to $137.4 per fortnight.
The following charts illustrate an example projection of Bruce and Anne's retirement using fixed assumptions for investment returns and how long they will live1.
The first chart shows how their retirement spending is funded each year and the second chart breaks down their total lifetime spending over retirement into initial capital, earnings and age pension entitlements until Anne is age 91, when in this scenario we assume both persons have passed away.
The first chart above illustrates that the amount of age pension Bruce and Anne might have received under the pre-1 January rules would have gradually increased over their retirement as they spend down on their savings.
While Bruce and Anne's age pension entitlement under the new rules is significantly lower at 1 January 2017, the higher taper rate means their age pension entitlements increase more quickly as they spend their savings.
Despite the expected $474.75 fortnightly reduction in the age pension at 1 January 2017, Bruce and Anne's estimated total lifetime age pension entitlements reduces by less than 2 per cent as a result of the new rules.
While the timing of when they receive their age pension entitlements changes, the overall amount they receive over their retirement is actually very similar.
The higher drawdown on their savings at the start of their retirement does mean that Bruce and Anne would have around 20 per cent less capital remaining at the end of their life expectancy under this scenario.
The above analysis considers just one market scenario. If we test Bruce and Anne's retirement through 2,000 market and lifespan scenarios we can determine the confidence they can have that their retirement spending will be sustainable for life.
Retirement is considered to be sustainable if there are sufficient assets to maintain their desired lifestyle for the rest of their lives.
We compare the level of confidence they would have in their retirement spending plans pre and post the 1 January assets test changes below.
The age pension changes have reduced the probability that Bruce and Anne's savings will last as long as they do by 5 per cent.
Is it worth spending some savings to maintain your age pension?
If Bruce and Anne wished to continue receiving the same amount of age pension under the new rules as they did pre-1 January they would have had to reduce their assessable assets by approximately $158,000 prior to 1 January 2017.
These assets would need to be spent or invested in non-assessable assets such as the family home in order to not count towards the age pension means tests.
However, spending a sizable portion of their savings in order to boost their age pension entitlements would have a significant impact on the sustainability of their retirement plans.
It would increase the chance of them outliving their savings by around 17 per cent, with their confidence level falling from 81 per cent to 64 per cent.
Despite many retirees likely to face a significant reduction or loss of age pension from 1 January 2017, when looked at from a broader perspective the biggest change is likely to be the timings of when payments are received rather than the overall level of entitlements.
It may not be necessary to make significant reductions in living standards or large changes to savings in order to maintain a sustainable retirement plan.
1 Assumes an annual return net of fees on the share portfolio of 6.7 per cent, cash of 3.5 per cent, and on SMSF of 5.7 per cent, and inflation of 2.50 per cent. It is assumed Bruce passes away at age 88 and Anne at age 91. These are based on best estimate assumptions for asset class returns and life expectancies.
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