A number of important changes to the social security assets test that take effect from 1 January 2017.

This article is for educational purposes only and is no longer available for CPD hours.

For those who will see a reduction or cancellation of the Age Pension, it’s important for them to review their retirement plans to ensure they have sufficient funds to meet retirement income needs.

Strategies to reduce assessable assets for social security clients receiving a part pension determined by the assets test will become twice as effective from 1 January 2017.

This article highlights the impact of assets test reduction strategies through a number of case studies.

Assets test changes from 1 January 2017 and their impact on strategies

From 1 January 2017:

• the lower assets test thresholds for both homeowners and non-homeowners will increase.
• the assets test taper for the pension assets test will double from $1.50 per fortnight to $3 per fortnight per $1,000 of assets over the asset free area.

From a strategy perspective, the increased taper rate means that from 1 January 2017, part pensioners whose pension is determined by the assets test will receive an effective return of 7.8 per cent per annum for every dollar that their assessable assets are reduced. This compares with 3.9 per cent per annum under current rules. Note that where only one member of a couple is eligible for a pension (for example, only one is over Age Pension age), these percentage based returns are halved.

Both changes applying from 1 January 2017 mean that the optimum level of assets to hold, and therefore the strategies implemented, will be different for many clients from that time.

Importantly, with the changes applying to both existing and new pensioners from 1 January 2017, strategies put in place prior to this date also need to be formulated with the new rules in mind.

What strategies should be considered?

Depending on a client’s situation, the following strategies may be effective at reducing their assessable assets and maximising their pension entitlements in the post 1 January 2017 world:

• Maximising the super balance of a spouse while they are under Age Pension age.
• Improving or purchasing a more expensive principal home.
• Gifting within allowable limits.
• Gifting more than five years prior to Age Pension age.
• Purchasing funeral bonds and prepaid funerals.
• Purchasing long-term annuities with a depleting asset value.

The following case studies highlight three of these strategies in action, the additional impact they have from January 2017, and importantly, how they should be implemented differently for the January 2017 rules.

Case study 1: Maximising younger spouse’s super while under Age Pension age

Jean (age 65) and Peter (age 60) are retiring and have the following assets:

• Principal home: $450,000
• Home contents and car: $50,000
• Bank account and term deposits: $50,000
• Jean’s account based pension (ABP): $650,000
• Peter’s super (accumulation): $300,000

Jean would like to maximise any Age Pension she might be entitled to. Let’s look at implementing a strategy of recontributing from Jean’s ABP to Peter’s super and leaving it in accumulation phase while he remains under Age Pension age.

Strategy implementation and impact: current rules

To optimise Jean’s social security situation under current rules, the best course of action is to cash out $453,500 from her ABP and recontribute it to Peter’s super account as a non-concessional contribution using the bring forward rule*1*. Peter’s super is then left in accumulation phase where it is exempt from the assets and income tests.

By recontributing this amount, their assessable assets are reduced to the same level as the lower assets test threshold, meaning they will receive the maximum Age Pension under the assets test. Note that they will also receive the maximum Age Pension under the income test in this case.

Table 1 has the impact of this strategy.

Table 1

	No recontribution	Recontribution
Assessable assets	$750,000	$296,500
Jean’s Age Pension under assets test (pa)	$8,283	$17,126
Assessable income (pa)	$21,526	$6,787
Jean’s Age Pension under income test (pa)	$8,283	$17,126
Jean’s Age Pension (pa) – actual	$8,283	$17,126

 

This comparison shows that Jean can obtain an additional $8,843 per annum in Age Pension as a result of recontributing $453,500 and Peter leaving his super balance in accumulation phase. However, this needs to be offset by the fact that more of their super is now in accumulation phase and subject to tax on earnings. Assuming a 5 per cent per annum return taxed at 15 per cent in accumulation phase, this is an additional tax of $3,401 per annum.

The net benefit of the strategy is therefore $5,442 per annum, which is an additional return of 1.2 per cent per annum on the $453,500 recontributed.

Strategy implementation and impact: January 2017 rules

To optimise Jean’s social security situation under the January 2017 rules, the best strategy is now to cash out only $361,929 from her ABP and recontribute it to Peter’s super account. Again, Peter’s super is then left in accumulation phase.

By recontributing this amount, their assessable assets are reduced to a level still above the new January 2017 lower assets test threshold ($375,000), being the level of assets at which the income and assets tests produce the same result. In this case, there would be no social security benefit in reducing assessable assets further, as the income test would be the determining test.

The impact of this strategy is as follows in Table 2.

Table 2

	No recontribution	Recontribution
Assessable assets	$750,000	$388,071
Jean’s Age Pension under assets test (pa)	$2,758	$16,873
Assessable income (pa)	$21,508	$9,745
Jean’s Age Pension under income test (pa)	$13,932	$16,873
Jean’s Age Pension (pa) – actual	$2,758	$16,873

 

This comparison shows that under the January 2017 rules, Jean can obtain an additional $14,115 per annum in Age Pension as a result of recontributing $361,929 and Peter leaving his super balance in accumulation phase. Again, this needs to be offset by the impact of tax on earnings in accumulation phase on the recontributed amount. Assuming a 5 per cent per annum return taxed at 15 per cent in accumulation phase, this is an additional tax of $2,714 per annum.

The net benefit of the strategy is therefore $11,401 per annum, which is an additional return of 3.15 per cent per annum on the amount recontributed.

Analysis

The first thing that’s obvious is how much worse off Jean and Peter are from 1 January 2017 if they do nothing – Jean stands to lose $5,525 per annum in Age Pension as a result of the assets test changes.

However, looking at the impact of their strategy, it is clear that it is much more effective under the January 2017 rules. In dollar terms, they benefit by $5,272 more by implementing the strategy under the January 2017 rules.

In percentage terms, the impact is even more impressive, as a smaller amount of money is needed to be recontributed under the January 2017 rules. As a percentage of each dollar required to be recontributed, the strategy returned a benefit of 1.2 per cent per annum under current rules, but 3.15 per cent per annum under the January 2017 rules.

Case study 2: Gifting within allowable limits

Donald (age 75) has the following assets:

• Principal home: $300,000
• Home contents: $30,000
• Bank account and term deposits: $180,000
• Share portfolio: $100,000

Donald would like to gift money to his grandchild and wants to understand how this will impact his Age Pension. Let’s look at the impact of gifting $10,000 during this financial year – the maximum Donald can gift before deprivation provisions start to apply.

Strategy implementation and impact: current rules

The impact of gifting $10,000 is as follows in Table 3.

Table 3

	No gifting	Gifting
Assessable assets	$310,000	$300,000
Donald’s Age Pension under assets test (pa)	$18,782	$19,172
Assessable income (pa)	$8,362	$8,037
Donald’s Age Pension under income test (pa)	$20,672	$20,835
Donald’s Age Pension (pa) – actual	$18,782	$19,172

 

Under current rules, Donald’s gift has seen his Age Pension increase by $390 per annum. Assuming a bank account interest rate of 2 per cent per annum, however, he has lost $200 per annum of interest because of his gift. This is a net benefit of $190, or 1.9 per cent per annum.

Strategy implementation and impact: January 2017 rules

The impact of gifting $10,000 is as follows in Table 4.

Table 4

	No gifting	Gifting
Assessable assets	$310,000	$300,000
Donald’s Age Pension under assets test (pa)	$18,382	$19,162
Assessable income (pa)	$8,351	$8,026
Donald’s Age Pension under income test (pa)	$21,051	$21,213
Donald’s Age Pension (pa) – actual	$18,382	$19,162

 

Under the January 2017 rules, Donald’s gift has seen his Age Pension increase by $780 per annum. Again, assuming a loss of $200 in bank account interest due to his gift, this is a net benefit of $580 or 5.8 per cent per annum.

Analysis

The first thing to note about all gifting strategies is that they involve the permanent loss of capital by the client and cannot be used to increase their wealth overall. Leaving aside the loss of capital, it is important to analyse the net ongoing social security impact of gifting both under the current and January 2017 rules.

Under the current rules, Donald’s gifting strategy yields a net benefit of 1.9 per cent per annum, compared with 5.8 per cent per annum under the January 2017 rules – which is an additional 3.9 per cent per annum return.

This highlights that for asset tested clients looking to implement gifting strategies (within allowable gifting limits), these strategies can leave the client in a relatively better position under the January 2017 rules than under current rules.

Case study 3: Long-term annuity

John, aged 70, is a non-homeowner and has the following assets:

• Contents: $50,000
• Bank account and term deposits: $125,000
• Account based pension (ABP): $500,000

John draws 6 per cent of his ABP each year ($30,000). He wants to also see if he can maximise his Age Pension, so he can receive some additional income without needing to draw further money from his super. Let’s look at the impact of a strategy involving John rolling over $200,000 from his ABP into a superannuation lifetime annuity.

Strategy implementation and impact: current rules

John rolls $200,000 from his ABP to a lifetime superannuation annuity with an annual payment of $10,865 per annum (paid monthly and indexed by 2 per cent per annum with a guaranteed period of 10 years) and a social security deduction amount of $10,406 per annum. To continue to receive $30,000 per annum from his super, he then needs to draw $19,135 from his ABP.

After one year (assuming current rules remain in place and assuming his ABP earns 5 per cent per annum), the impact of John’s strategy is as follows in Table 5.

Table 5

	No annuity	Annuity
Assessable assets	$670,000	$660,459
John’s Age Pension under assets test (pa)	$10,651	$11,023
Assessable income (pa)	$19,412	$13,617
John’s Age Pension under income test (pa)	$15,147	$18,045
John’s Age Pension (pa) – actual	$10,651	$11,023

 

Under current rules, John’s Age Pension has increased by $372 due to the depleting of the purchase price of his annuity under the assets test. This benefit is only 0.19 per cent of the amount invested in the annuity, although this strategy involves benefits that may compound over a number of years.

Strategy implementation and impact: January 2017 rules

John rolls $200,000 from his ABP to a lifetime superannuation annuity with the same characteristics as above. He again draws $19,135 from his reduced ABP under this strategy.

After one year (assuming January 2017 rules have come into effect and that his ABP earns 5 per cent per annum), the impact of John’s strategy is as follows in Table 6.

Table 6

	No annuity	Annuity
Assessable assets	$670,000	$660,459
John’s Age Pension under assets test (pa)	$5,902	$6,646
Assessable income (pa)	$19,401	$13,606
John’s Age Pension under income test (pa)	$15,526	$18,423
John’s Age Pension (pa) – actual	$5,902	$6,646

 

Under the January 2017 rules, John’s Age Pension has increased by $744, again due to the depleting of the purchase price of his annuity under the assets test. This benefit is now 0.37 per cent.

Analysis

Without implementing any strategies, John receives around $4,749 less Age Pension under the January 2017 rules than under current rules.

The implementation of this strategy under the January 2017 rules, although still of modest benefit in the first year, is twice as effective for John than under current rules.

If we project forward how this benefit would grow over the next 10 years, assuming $30,000 income was required from super (indexed to CPI), all rates and thresholds were indexed by 3 per cent per annum and that John’s ABP always earned 5 per cent per annum, the increase in Age Pension as a result of this strategy under both current rules and the January 2017 rules, is outlined in Table 7.

Table 7

	Current rules	January 2017 rules	Benefit of January 2017 rules
Increased Age Pension pa after year 1	$372 (0.19% of annuity purchase price)	$744 (0.37% of annuity purchase price)	$372
Increased Age Pension pa after year 2	$734 (0.37%)	$1,468 (0.73%)	$734
Increased Age Pension pa after year 3	$1,085 (0.54%)	$2,170 (1.09%)	$1,085
Increased Age Pension pa after year 4	$1,425 (0.71%)	$2,849 (1.42%)	$1,425
Increased Age Pension pa after year 5	$1,752 (0.88%)	$3,504 (1.75%)	$1,752
Increased Age Pension pa after year 6	$2,066 (1.03%)	$3,911 (1.96%)	$1,845
Increased Age Pension pa after year 7	$2,366 (1.18%)	$2,015 (1.01%)	-$351
Increased Age Pension pa after year 8	$2,035 (1.02%)	$1,840 (0.92%)	-$195
Increased Age Pension pa after year 9	$1,656 (0.83%)	$1,656 (0.83%)	$0
Increased Age Pension pa after year 10	$1,462 (0.73%)	$1,462 (0.73%)	$0

 

It is interesting to note that while the Age Pension benefits, as a result of undertaking this strategy, grow in future years both under current and the January 2017 rules, this benefit starts to reverse after a point in time because the income test has taken over as the determining test – this occurs in the eighth year for current rules and sixth year for the January 2017 rules.

Also of note is that the benefits of undertaking the strategy under the January 2017 rules compared to the current rules increase up until the end of year six. From that point on, the benefit becomes negative for two years because by that point, using the strategy under the January 2017 rules, assessable assets have already reached the lower assets test threshold and the client has become income tested.

Therefore, the strategy cannot add as much value as under the current rules, where the assets test is still the determining test.

However, by the end of year eight, John is income tested both under the current and January 2017 rules, so the strategy is equally beneficial per annum by the end of that year.

While there are times during the 10 year projection when the January 2017 rules have provided benefit, and times where the current rules were more effective, the January 2017 rules still proved far better overall compared with the current rules, adding additional cumulative benefits of $6,667 in Age Pension over the 10 years when the strategy is implemented.

Case study assumptions

Client’s asset and income levels are the same in both cases – ie, they are not increased or indexed for the January 2017 scenario.

Rates (eg, maximum Age Pension) and thresholds (eg, lower income test threshold) are assumed to increase by 1.5 per cent between July 2016 and January 2017.

Deeming thresholds increase by 1.5 per cent between July 2016 and January 2017, but current deeming rates remain unchanged.

Lower assets test thresholds increase to their legislated levels on 1 January 2017 and the assets test taper rate doubles to $3 per fortnight.

All account based pensions are deemed for income test purposes.

Footnote

1. In the 2016 Federal Budget, a $500,000 lifetime cap on non-concessional contributions was proposed to commence from Budget night, 7.30 pm (AEST) on 3 May 2016. If legislated, it is proposed to take into account all non-concessional contributions made on or after 1 July 2007.