In the current market environment clients are focusing on the finer details (such as fees or administration proficiency) of their current pension provider. If you are advising your clients to change pension provider, you may need to determine if their income tested age pension entitlement will be impacted.
In this article we will investigate the myriad of issues that can impact your client’s age pension entitlement under the income test when changing pension providers. Most importantly, we will also determine the impact of the increased life expectancies when commencing a pension from 1 January 2010.
The Federal Government released the Australian Life Tables 2005-07 on 28 November 2009. The gap between male and female life expectancies at birth is now the lowest it has been for over 50 years. The new Life Tables will be required to be used by clients when commencing new pensions from 1 January 2010.
The changed life expectancies will primarily affect the calculation of the deductible amount under the income test of pensions for Centrelink/DVA purposes. Under these rules, the amount of annual pension payments excluded from the income test is determined by the deductible amount. The deductible amount is calculated at commencement of the pension by dividing the purchase price by the client’s life expectancy.
It is important to recognise an increased life expectancy can reduce the client’s deductible amount; and increase the amount of pension included within the income test for age pension purposes. Combining this with the increased income test taper rate of 50 cents from 20 September 2009, clients like Ruby in the following case study, who decides to change pension providers during a financial year, could see a further reduction in their age pension entitlement.
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An example
Ruby (age 67) is a part age pensioner assessed under the income test. Any changes in her assessable income for social security purposes will have a direct impact on her age pension.
Ruby commenced an allocated pension in June 2005 with a purchase price of $300,000 and a deductible amount of $13,129 (ie $300,000 / 22.851 ). She is changing pension providers at 2 April 2010 and she is concerned about the taxation and Centrelink implications.
With the abolishment of reasonable benefit limits and the introduction of tax-free pension payments for retirees over age 60, there will be no taxation implications when transferring pension providers.
From a Centrelink perspective, all of her current pension payments of $5,625 (ie $225,000 x 2.5 per cent calculated at 1 July 2009) from her allocated pension are excluded under the income test. This is due to the current deductible amount of $13,129 (as shown in table 1 using the old life tables) being above the reduced minimum pension payment of $5,625.
As Ruby’s adviser, you are thinking whether or not the increased life expectancy will reduce her Centrelink deductible amount and part age pension entitlement under the income test.
If Ruby’s pension account balance was still $300,000, her increased deductible amount (as shown within table 1) will be calculated upon commencement of her new pension using the new life tables. In the current market environment, it is reasonable for declined asset values to reduce Ruby’s deductible amount and the increased life expectancy would reduce it even further.
Table 1 – Increased deductible amount & age pension entitlement
|
Using old life tables |
Using old life tables |
Using new life tables |
|---|---|---|---|
Commencement date |
1/06/2005 |
1/04/2010 |
1/04/2010 |
Purchase price |
$300,000 |
$300,000 |
$300,000 |
Life expectancy |
22.85 |
19.49 |
19.92 |
Centrelink deductible amount |
$13,129 |
$15,393 |
$15,060 |
Other factors to consider
Under the current market conditions it is more likely your client’s pension account balances have declined with the market. You may find it difficult to warrant the change in pension provider once you consider the following factors:
A. Declined asset values.
B. Centrelink’s income test assessment for a mid year superannuation pension commencement.
C. Reverting to the standard minimum pension payment from 1 July 2010.
For the remainder of this article, we will investigate how the above factors will impact Ruby’s financial situation.
A. Declined asset values
Due to the decline in the investment market, Ruby’s pension account balance is now $250,000. As shown within table 2, her deductible amount will reduce by $579 and eventually when her pension payments from her new account based pension exceed the deductible amount, it will result in an automatic reduction in her age pension of $289.50 pa (or $11.13 per fortnight). In contrast, the age pension reduction using the old life tables would be $151.01 pa (or $5.81 per fortnight).
Table 2 – Reduced deductible amount & age pension entitlement
|
Using old life tables |
Using new life tables |
Difference |
|---|---|---|---|
Commencement date |
1/06/2005 |
1/04/2010 |
|
Purchase price |
$300,000 |
$250,000 |
|
Life expectancy |
22.85 |
19.92 |
|
Centrelink deductible amount |
$13,129 |
$12,550 |
-$579 |
Reduction in age pension pa |
|
|
-$289.50 |
B. Centrelink’s income test assessment for a mid year superannuation pension commencement
On the surface you might be thinking a reduction in Ruby’s age pension entitlement of $289.50 pa (or $11.13 per fortnight) over the longer term may not be significant. However, as a rule of thumb, this could be made worse if Ruby:
When a superannuation pension is commenced, Centrelink will annualise the pension payment to be received to allow the direct comparison against the deductible amount which is an annual figure. In Ruby’s case, she will receive the pro-rata pension minimum of $1,541 2 which is an annualised pension payment of $6,250 (ie $1,541 x 365/90) and in fact this is less than her revised Centrelink deductible amount of $12,550. Ruby will not see a reduction in her age pension for the remainder of the 2009/2010 financial year.
In contrast, if Ruby was to receive a nominated pension payment of $5,000 for the remainder of the financial year, her age pension entitlement will reduce by $148.61 per fortnight (ie $5,000 x 365/90 - $12,550 = $7,728 x 50 cent reduction) for the remainder of the 2009/2010 financial year.
Strategy tip: If Ruby needed additional income, an irregular pension payment could be made close to 30 June 2010. Centrelink will only revise Ruby’s age pension entitlement for the remaining days of the financial year and this will have no impact on her 2010/2011 financial year age pension assessment. Ruby could also consider a lump sum withdrawal prior to the commencement of her new pension to avoid the income test complications.
For more details on Centrelink’s assessment for mid year pension commencements, please refer to the Guide to Social Security Law.
C. Reverting to the standard minimum pension payment from 1 July 2010
From 1 July 2010, the reduced minimum pension payment will revert to the standard percentages and this could also impact Ruby’s age pension entitlement. In fact, we are more interested in the movement of the superannuation pension account balance each 1 July.
Reverting to the standard minimum pension payment percentages will mean clients like Ruby will return to receiving pension payments above the Centrelink deductible amount. In fact, in Ruby’s case her superannuation pension account balance need only increase by $1,000 to $251,000 (ie new Centrelink deductible amount of $12,550 divided by minimum pension payment percentage of 5 per cent) before she will see a reduction of 50 cents in her age pension entitlement for each and every dollar above this amount.
If Ruby was to see an investment return to 30 June 2010 of say 5.5 per cent, her superannuation pension account balance would be $263,750. In simple terms, her age pension entitlement would reduce by $318.75 pa (ie $263,750 x 5 per cent - $12,550 x 50 cent reduction).
In contrast, if Ruby had not changed providers and retained her old superannuation pension, the account balance could increase to $262,580 before her age pension entitlements would reduce her age pension under the income test (ie $13,129/5% = $262,580). Since the account has increased to $263,750, age pension entitlement would reduce by $29.25 pa (ie $263,750 x 5 per cent - $13,129 x 50 cent reduction).
Strategy tip: Ruby should consider retaining her current superannuation pension until the value of the assets improves with the market to the break even point of at least $262,580. As outlined within table 1, if Ruby was to change pension providers when the balance is around $300,000, she will improve her Centrelink deductible amount lessening the impact on her age pension entitlement.
Conclusion
Commencing a pension after 1 January 2010 will certainly reduce the Centrelink deductible amount for clients and impact their age pension entitlement if determined under the income test. Before you decide to recommend clients to change providers, you should consider the current and long term impacts to their age pension entitlements.
Delaying the change to a new pension provider might be in the best interest of your clients and this could be revisited in subsequent annual reviews. Once more, the value and benefits of seeking financial advice can be demonstrated to your clients.
1Based on age at commencement of 63.
2Pro-rata minimum pension payment of 2.5 per cent based on a $250,000 account balance at commencement at 1 April 2009 (ie $250,000 x 2.5 per cent x 90/365).
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