Should you be taking action before 1 January 2015 in order to take full advantage your age pension entitlement?

The value of Age Pension entitlements in providing financial support to individuals in retirement cannot be under-estimated. Even those who would consider themselves to be ‘wealthy’ may find that at some point in their retirement they would be eligible for at least a part-pension and that this would enable them to better support their standard of living.

The changes that are set to take affect from 1 January 2015 determine how superannuation income streams (focusing on the more common account-based pensions in this article) are assessed in applying the income test to determine Age Pension eligibility. There is no change to the asset test. Essentially, this change is particularly relevant for individuals who have an existing account-based pension or are considering setting one up in the near future, and are eligible for Age Pension payments prior to 1 January 2015.

The need to assess the situation prior to that date (the sooner the better) arises because the rules for assessing existing account-based pensions will be ‘grandfathered’. This means that existing account-based pensions will continue to be assessed under the ‘old rules’ after 1 January 2015 until the account-based pension is either fully commuted or the individual is no longer eligible to receive the Age Pension.

So here’s the challenge – some people will be better off with their account based pensions being assessed under the ‘old’ rules, and some people will be better off with their account based pensions being assessed under the ‘new’ rules. Furthermore, some people would benefit from the old rules being applied for a period of time and then making some changes at a point in the future so as to be assessed under the new rules. What’s more, some people will have no power to do anything about it at all and so have no choice about how their account based pensions might be assessed. Confused? Let me try to break it down.

Who has no choice?

For those who will not become eligible for and apply for the Age pension until after 1 January 2015, there is no point in making any changes to existing account-based pensions since the new rules will automatically apply from the time that the Age Pension is applied for.

What about those who can make a choice and take actions accordingly?

Before making a decision, first it is necessary to understand how the old rules work and how the new rules are different. In order to get to that point it is important to understand how Centrelink assesses Age Pension entitlements under what is known as the ‘Means Test’.  The Means Test involves separately applying an Asset test and an Income Test and the test that produces the lowest Age Pension payment is the one that applies. For more information on these tests as well as rates and thresholds, follow this link.

What are the ‘old’ rules under the Income Test?

When the ‘old’ (or at least they will be ‘old’ from 1 January 2015) Income Test rules are applied in assessing the income from account-based pensions, the following formula is applied:

= Annual Payment – Deduction Amount

Obviously, the higher the Deduction Amount, the lower the amount of income counted in the Income Test and the higher the Age Pension payment (where the income test is the dominant test).

The deduction amount is calculated by:

= PP/RN

PP = Purchase Price less Commutations

RN = Relevant Number (life expectancy at commencement)

Therefore, as the relevant number decreases, the deduction amount increases. That is, the older a person is at commencement of the pension, the lower the assessable income counted in the Income Test.

This has given rise to the possibility that for those who would seek to be assessed under the ‘old rules’, now is the time to cease (fully commute) existing account-based pensions and commence new ones so as to ‘lock in’ the best possible deduction amount. Any pensions commenced after 1 January 2015 will automatically be assessed under the new rules and it will no longer be possible to increase the deduction amount in this way. After that date, if a recipient of an account based pension assessed under the ‘old’ rules temporarily loses Age Pension entitlement, upon re-gaining the Age Pension the new rules will be applied – this could happen for example where the Asset Test is dominant and under favourable market conditions the capital value of the pension is temporarily above the eligibility threshold.

What are the ‘new’ deeming rules under the Income Test?

From 1 January 2015, any new account-based pensions commenced will simply be assessed the same way that income from other financial assets are currently being assessed. That is, if you are single, the first $48,000 (or for a couple, $76,600) of your financial investments is deemed to earn income at 2% per annum and any amount over that is deemed to earn income at 3.5% per annum. Age pension payments are not affected by any actual income is higher than the deemed rates.

So which rule will lead to a better outcome overall?

Which rule is most beneficial will depend on the financial situation of each individual being assessed. It helps to understand that the Asset Test generally dominates the Income Test early on in retirement, so the benefit of having an account based pension that is assessed under the ‘old’ Income Test rules may not materialise for some time. That is not to imply that the idea should not be considered, the benefits of having the ‘old’ rules apply could be quite significant for some.

Further, it might be beneficial to continue under the grandfathered ‘old’ rules until the point where the capital of the account-based pension is depleted and the ‘new’ rules give a better outcome. At this point the member may commute and commence a new account-based pension. This action is likely to be beneficial when the Income Test is dominant and the ‘new’ Income Test rules are closer to the Asset Test result than the ‘old’ Income Test rules.

Whilst each situation is different, those with Age Pension entitlements that are already, or will soon be dominated by the Income test are likely to obtain the most gains from fully commuting and commencing a new account-based pension prior to 1 January 2015.

Anyone considering fully commuting and re-commencing an account-based pension should seek specialised financial advice given that the process would involve additional considerations. Listed below is just a number of factors that could affect the decision now or at some point in the future:

  • Tax components being altered during the process
  • Potential deeming rate increases in the future
  • Pensions that will no longer operate under the transition to retirement rules in the future effectively ‘re-commencing’ at the point of change (unless set-up otherwise)
  • Potential impact of a death of one member of a couple (and if the account-based pension is reversionary)
  • If the pension is already a pre September 2007 pension that is already either fully or partially exempt from the means test.
  • Planned expenditures
  • Market shocks, investment strategies and asset allocations
  • Downsizing of the family home
  • Non superannuation income and assets
  • Other investments that are exempt from the means test

 

The information in this document is factual information only and is not intended to be financial product advice or legal advice and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances.  While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Star Super Services Pty Ltd and Star Super Advice Pty Ltd is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. Tax is only one consideration when making a financial decision. We recommend that you seek appropriate professional advice before making any financial decisions.