Thursday 17 August 2023

How the Age Pension Asset Test is designed to penalize the average Australian couple if they make additional super contributions

Based on 2019 statistics, the average man aged 60-64 and approaching retirement had a superannuation balance of $178,800. And the average woman aged 60-64 and approaching retirement had a superannuation balance of $137,050 (due to having contributed less into superannuation over their working lives and, possible, the fact that women typically have slightly lower financial risk tolerance that men, so may have their super invested in slightly more conservative asset allocations, providing lower yield and lower volatility).

So, for a 'typical' homeowner couple the average combined superannuation balance just before retirement would have been around $315,850.

Assuming they only had $30K of personal assets (car, jewellery, furniture etc.) in additional to their family home and superannuation, they would have become eligible for the full Age Pension at age 67*.

Assuming they have put their superannuation into an account based pension when they retired, their superannuation in pension phase would provide some retirement income. For simplicity I have assumed the minimum withdrawal rate (which is 5% for someone aged 68).

The amount of Age Pension they receive would be the standard rate for a homeowner couple of $1,604 per fortnight (as at March 2023) as long as their Age Pension was not reduced due to the Assets or Income tests. Generally (due to deemed income rates being fairly modest, and most retirees not earning much other income) the relevant test that will start to impact the amount of Age Pension entitlement is the Assets Tests. The family home is exempt, but other financial assets (such as superannuation) and personal assets (such as cars, jewellery, furniture etc.) are all counted for the Assets Test.

Lets assume this 'typical' homeowner couple has $30K of personal assets. Now, the Age Pension Asset Test threshold (where the Age Pension starts to reduce by $3 per fortnight for every additional $1,000 of assets) is $451,500 for a homeowner couple. So the couple could own their principal residence, have $30K of personal assets (car etc) and have $420,000 combined total superannuation and receive the full Age Pension ($41,704 per year).

Now, the general 'rule of thumb' for a homeowner couple to have a 'comfortable' retirement is their income in retirement should be around $70,000 per year. So, the Age Pension alone won't provide a 'comfortable' retirement for a retired homeowner couple.

But having some superannuation pension will boost their total retirement income -- up to a point.

The sad reality is that every $1,000 of superannuation balance for the couple over $420,000 would reduce their Age Pension entitlement by $3 per fortnight ($78 per year). But if their extra $1,000 in superannuation will only provide an extra $50 of income (at the 5% withdrawal rate), they would actually see a reduction in total retirement income of -$28 for every extra $1,000 they have accumulated in superannuation during their working lives!

This 'penalty' for having more than the average amount accumulated in superannuation will continue to impact as long as you have any entitlement to a partial Age Pension. Once a homeowner couple had total assets over $986,500 they would not receive any Age Pension**, so having more superannuation would provide more retirement income as they would not be any Age Pension left to reduce!

Overall, the interaction of the Age Pension asset test and combined superannuation balance on total retirement income for a homeowner couple is shown below. The orange horizontal stripe shows the $70K pa needed for a 'comfortable' retirement for a home-owning couple. The blue arrow points to the average combined superannuation balance at retirement age of $315K, and that for combined superannuation balances over roughly $450K up to $900K having accumulated more in superannuation will actually mean you end up with less total retirement income (Age Pension entitlement plus minimum withdrawal from superannuation in pension phase).

The graph might not be 100% correct (it is based on a quick review of the Age Pension Asset test rules - for accurate calculation of Age Pension entitlement you have to consult Centrelink -- which makes planning and modelling such interactions quite difficult, even for financial advisers), but illustrates the general interaction of Age Pension entitlement and having accumulated more than 'average' in superannuation.

One interesting thing to note is that while the Age Pension and asset test threshold are generally indexed, the 'average' superannuation balance will be increasing at a faster rate, due to the increase in SGL contribution rates in recent years. So more and more retirees are going to find that they would be better off (in terms of total retirement income) by withdrawing some of their superannuation as a lump sum and spending it!

Of course this could quite easily be fixed by eliminating the 'dip' in total retirement income by simply changing the rate at which Age Pension entitlement is reduced for every extra $1,000 in assets above the Age Pension asset test threshold. Reducing it from $3/$1000 to $2/$1000 would replace the 'dip' with a 'flat spot' between $420K and $1MM combined super balance. And anything less than $2/fortnight reduction for every extra $1,000 in assets would mean that it was actually worthwhile accumulating some extra superannuation to provide a boost to retirement income...

I doubt that there will be any 'tweaking' of the Asset Test to eliminate this 'feature', as most Labor voters would not be affected (as they are likely to end up with below average superannuation balances), and the more affluent Liberal voters will likely never be entitled to receive any Age Pension, so don't care. So, as usual, it is the 'middle class' earning around the average income and retiring with around the average superannuation balance that would be most affected.

PS. It isn't actually as simple as this analysis suggests - you would also have to take into account the benefit of tax savings due to making additional concessional superannuation contributions (eg. via salary sacrifice) and so forth. So whether or not aiming to end up with a higher than average superannuation balance will depend on individual circumstances. You can also alter the scenario by using some superannuation to move to a better 'principle residence' (that is exempt from the asset test) in retirement.

*Yes - there are a lot of more detailed eligibility conditions (eg. being an Australia resident, year of birth etc) but I am only doing a simply illustration for a 'typical' case here.

** Unless they are legally blind (less than 6/60 vision in both eyes, wearing corrective lenses), in which case the Age Pension (blind) is not subject to the Asset or Income test...

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