Centrelink and aged care: The ‘retain and rent’ strategy

15 March 2017

Robert Simon

Robert Simon is Technical Strategy Manager at AMP. Prior to that he was Senior Technical Services Adviser at ipac Securities - a position he held from June 2004 to June 2015.

It’s no secret the Government is tightening the purse strings. Since 2015, the Government has legislated changes to social security means testing to reduce the level of Centrelink support for retirees with some assets of their own.

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

Now the Government is changing the rules for a specific group of retirees – namely, homeowners entering residential aged care who choose to keep and rent out their former home. These changes to Centrelink means testing of the former principal home (for those entering residential aged care on or after 1 January 2017), are included in the Budget Savings (Omnibus) Bill 2016. This Bill received Royal Assent on 16 September 2016.

This article will discuss these changes in detail, along with their interaction with 1 January 2017 Centrelink asset test changes. In particular, we consider the impact of the changes on the ‘retain and rent of the former home’ strategy.

What are the changes to the assessment of the former home?

Importantly, changes to the assessment of the former home will affect only:

  • those who enter a residential aged care facility on or after 1 January 2017;
  • those who are changing facilities and have left the previous facility for more than 28 days.

Existing residents, or those who are able to move facilities within 28 days, are exempt from the new rules.

From 1 January 2017, the indefinite exemption granted to former homes belonging to people entering residential aged care will cease. Currently, this indefinite exemption lets those who pay periodic accommodation costs1 and rent out their former home, keep an income generating asset while maximising Centrelink/Department of Veterans’ Affairs (DVA) Age Pensions.

Removal of the indefinite exemption will cause net rental income from the former home to be counted by Centrelink/DVA when applying the income test.

Currently, when applying the assets test, however, a short-term exemption for the former home is available. This exemption will remain, as it is separate to the indefinite exemption and is not affected by changes coming into effect in 2017. The former home of a person entering a care situation will be exempt for up to two years from the date of entry2. During this period, the person will continue to be assessed as a homeowner.

Once the two-year period is over, the value of the former home will be assessed under the non-homeowner asset limits.

How does this change interact with the asset test changes also commencing on 1 July 2017?

In addition to changing how the former home will be assessed for Centrelink/DVA means testing, another set of changes will apply from 1 July 2017 – namely, the assets test changes.

These changes include:

  • increasing the asset test free limits; and
  • doubling the taper rate from $1.50 to $3.00.

These changes mean that a person whose assets exceed the asset test free limit, will lose their Age Pension at a much faster rate. The assets test limits are set out in Table 1.

Table 1

Household status Asset test free limit (current) Asset test free limit (from 1 January 2017) Maximum asset limit (current) Maximum asset limit (from 1 January 2017)
Single homeowner $209,000 $250,000 $793,750 $542,500
Couple homeowner (illness separated) $296,500 $375,000 $1,466,000 $960,000
Single non-homeowner $360,500 $450,000 $945,250 $742,500
Couple non-homeowner (illness separated) $448,000 $575,000 $1,617,500 $1,160,000

 

Although Centrelink assets test changes commence on 1 January 2017, the impact of renting out the former home on the assets test will not be felt until 1 January 2019, as a result of grandfathering and the two year exemption discussed earlier.

Entering residential aged care on or after 1 January 2017?

While the impact on assets test assessment will be delayed for two years, the impact on the income test is more immediate.

From 1 January 2017, Centrelink will assess rental income after deducting allowable rental expenses. Building write-off and depreciation expenses cannot be used to reduce the amount of rent counted as income. The information will be sourced from the most recent tax return and notice of assessment, and if a tax return is not available, two-thirds of the gross rent (minus interest income, where applicable) will be counted as income.

The inclusion of net rental income could significantly decrease the rate of the Centrelink Age Pension. Every dollar of assessable income over the income free limit will reduce Age Pension entitlement by 50c in the dollar. For a single homeowner and using current rates, $15,000 excess income will reduce the Age Pension by $7,500 per annum, or $288 per fortnight.

In some cases, depending on what other income is counted by Centrelink, inclusion of the net rental income may cause total loss of the Age Pension, such as those who receive a government defined benefit superannuation income stream.

Interaction of Centrelink means testing with aged care rules

The Government has referred to these upcoming changes as ‘harmonising’ Centrelink rules with aged care rules. This recognises the link between Centrelink means testing and aged care means testing.

However, the term is slightly misleading, as the aged care assets test assessment of the former home is separate from Centrelink rules. Under aged care rules, the former home is an assessable asset unless it is occupied by a protected person. A protected person3 is:

  • the person’s partner or dependent child;
  • the person’s carer, who has lived in the home for the past two years and during that time would be eligible for an income support payment;
  • the person’s close relative, such as a sister, brother, parent, child or grandchild, who has lived in the home for the past five years and during that time would be eligible for an income support payment.

If a protected person does not live in the former home, the value of the home is counted, but capped at $159,631.204. As a result, if the former home is rented to a person who is not a protected person, given the average values of residential property in Australia, it is likely that the capped value will be the amount assessed for the aged care assets test. This methodology of assessing the former home will not be affected by 1 January 2017 changes.

Importantly, there is no concept of a protected person for Age Pension means testing purposes.

On the other hand, income that is counted for aged care purposes not only includes the same income5 that is counted for Centrelink/DVA purposes, but also includes the amount of Age Pension6 the person is entitled to.

Therefore, including net rental income for the Centrelink income test is likely to reduce the amount of Age Pension and likewise decrease the amount of income counted for aged care fee purposes. Consequently, the 1 January 2017 changes are likely to reduce aged care fees when the former home is retained and rented.

Given that the changes lead to Age Pension reducing (not a good thing), as well as potentially aged care fees reducing (a good thing), what does this mean for the ‘rent and retain’ strategy?

Do these changes mean that the rent and retain strategy will no longer be effective from 1 January 2017?

Not necessarily. However, the combination of the assets test changes and means testing of the former home is likely to result in significant reduction or even loss of the Age Pension when the home is rented. In addition, unless clients have other assets to pay most of the accommodation costs upfront, the Daily Accommodation Payments (DAP) may exacerbate cash flow issues. Unless net rental income is high enough to replace the lost cash flow, the ‘retain and rent’ option may not be a viable option.

The following example will help to illustrate this point.

Example7

Kenny, aged 70 and single, is currently receiving a full Age Pension. His health is declining and he needs to move from his home of 40 years into a residential care facility. His assets and income are outlined in Table 2.

Table 2

Assets Capital Income
Cash (4% interest) $5,000 $200
Shares $5,000 $0
Principal home $1,000,000 $0
Account based pension (grandfathered, deductible amount $4,500) $75,000 $3,750
Age Pension $0 $22,805
Total $1,085,000 $26,755

 

Kenny has been asked to pay an accommodation payment of $300,000. Kenny has two main options as follows:

  1. Retain and rent the family home and pay $85,000 of the accommodation payment as a refundable accommodation deposit (RAD) and the balance as DAP. We have assumed Kenny generates assessable income of $27,000 per annum from his former home.
  2. Sell the family home and pay the accommodation payment in full as a RAD.

Table 3 compares the impact of the upcoming changes to assessment of the former home, as well as the assets test changes on the two options identified above.

Table 3

Rent and retain (if entry before 1 January 2017) Rent and retain (if entry on or after 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry before 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry on or after 1 January 2017)
Centrelink/DVA
Assessable assets $0 $08 $785,000 $785,000
Assessable income $0 $27,000 $22,175 $22,175
Age Pension $22,805 $11,437 $6,249 $0
Aged care
Assessable assets $244,631 $244,631 $1,080,000 $1,080,000
Assessable income $48,528 $37,160 $27,147 $27,147
Daily care fee $17,681 $17,681 $17,681 $17,681
Refundable Accommodation Deposit (RAD) $85,000 $85,000 $300,000 $300,000
Daily Accommodation Payment (DAP) $12,384 $12,384 $0 $0
Means-Tested Care Fee $12,249 $6,552 $16,867 $16,188
Total aged care fees $42,314 $36,616 $34,548 $33,869
Cash flow
Cash flow from investments $27,000 $27,000 $30,671 $30,671
Age Pension $22,805 $11,437 $6,249 $0
Aged care fees $42,314 $36,616 $34,548 $33,869
Total net cash flow $7,491 $1,821 $2,372 ($3,198)

 

It is obvious from Table 3 that cash flow is a key consideration, particularly if entering aged care in 2017. Although aged care fees are higher if Kenny enters aged care before next year and rents out his former home, these costs are effectively funded by the Age Pension and net rental income.

In contrast, if he enters care in 2017 and rents out the house, reduction of the Age Pension means that he will just have sufficient cash flow to fund his aged care costs. However, the small amount of surplus means that he may not have enough funds for unexpected increases in costs, such as expensive repairs.

To prevent this, he may have to sell his former home to free up cash, or consider using part of his RAD to fund any shortfall. Doing this will increase the DAP and may compound his cash flow problems over time. Based on this analysis, the best outcome for Kenny is to take advantage of the ‘retain and rent’ option before 1 January 2017. This will enable Kenny to benefit from grandfathering (exemption) from the new rules.

What if Kenny’s former home is worth $400,000 instead?

All information is the same as previously described, except that net rental income for the property will be $15,600.

Table 4

Rent and retain (if entry before 1 January 2017) Rent and retain (if entry on or after 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry before 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry on or after 1 January 2017)
Centrelink/DVA
Assessable assets $0 $0 $185,000 $185,000
Assessable income $0 $15,600 $2,837 $2,837
Age Pension $22,805 $17,137 $22,805 $22,805
Aged care
Assessable assets $244,631 $244,631 $485,000 $485,000
Assessable income $37,128 $31,460 $24,365 $24,365
Daily care fee $17,681 $17,681 $17,681 $17,681
Refundable Accommodation Deposit (RAD) $85,000 $85,000 $300,000 $300,000
Daily Accommodation Payment (DAP) $12,384 $12,384 $0 $0
Means-Tested Care Fee $6,534 $3,694 $4,256 $4,256
Total aged care fees $36,598 $33,758 $21,937 $21,937
Cash flow
Cash flow from investments $15,600 $15,600 $7,950 $7,950
Age Pension $22,805 $17,137 $22,805 $22,805
Aged care fees $36,598 $33,755 $21,937 $21,937
Total net cash flow $1,807 ($1,018) $8,818 $8,818

 

The outcome for Kenny is very different due to his home being a lower value than the previous example. If he chooses to sell the home and use the proceeds to pay the entire accommodation costs upfront as a RAD, his assessable assets and income drops to a level that qualifies him for the maximum Age Pension. This is because being of lower value, most of the proceeds will be used to fund the RAD (which is exempt from Centrelink/DVA means testing).

A lower home value also means that his aged care fees will be lower if he chooses to sell the former home and invest the remaining proceeds in financial assets. This is because the deemed income will be lower than the net rental income assessed under the income test in this case.

Consistent with the original scenario, entering aged care before 2017 will grandfather Kenny from the changes. However, besides cash flow there are other factors that should be considered as well, such as growth and income earning potential of the former home versus investing in financial assets, such as managed funds or term deposits.

What if net rental income is $35,000 instead?

Using the same information, but changing net rental income for the property to $35,000, the outcome changes as summarised in Table 5.

Table 5

Rent and retain (if entry before 1 January 2017) Rent and retain (if entry on or after 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry before 1 January 2017) Sell home and pay accommodation costs as 100% RAD (if entry on or after 1 January 2017)
Cash flow
Cash flow from investments $35,000 $35,000 $30,671 $30,671
Age Pension $22,805 $7,437 $6,249 $0
Aged care fees $46,864 $38,620 $34,548 $33,869
Total net cash flow $10,941 $3,817 $2,372 ($3,198)

 

The cash flow surplus for the ‘retain and rent’ under the new rules is higher than in the original example. The reason for this is because the increase in aged care fees is not as much as the increase in rental income, even after taking into account the reduction in Age Pension.

Nevertheless, the same issue must be considered, namely is the surplus adequate to manage unexpected costs? Also, the outcome is the same; entering aged care before 1 January 2017 will provide Kenny with more cash flow to fund his care costs.

Summary

Upcoming changes to social security means testing of the former home when entering care, coupled with changes to the assets test on 1 January 2017, make cash flow a key issue for consideration when discussing aged care with clients receiving an Age Pension benefit.

While each case will differ according to variables such as the value of the former home, net rental income, other assets and accommodation costs, these changes will generally lower the amount of Age Pension paid to homeowners renting their former homes to enter residential aged care. A reduced, or even lost Age Pension could force the sale of the former home in order to fund aged care costs, and make the ‘retain and rent’ option an ineffective strategy.

As highlighted by the example, advisers may wish to consider whether their clients could benefit from entering aged care prior to 1 January 2017, to take advantage of ‘grandfathering’.

Ling Wang, Technical Services Manager, IOOF.

Footnotes

  1. Daily Accommodation Payment (DAP) or Daily Accommodation Contributions (DAC).
  2. Social Security Act 1991 s11A (9)(b).
  3. Aged Care Act 1997 s44.26A (6).
  4. Based on thresholds current as at 20 September 2016.
  5. Rental income is included as income for residents who entered care on or after 1 January 2016.
  6. Minimum Supplement and Energy Supplement excluded.
  7. Rates current as at 20 September 2016 used in this example – Maximum Permissible Interest Rate is 5.67% (based on October to December 2016 rate).
  8. The former home is exempt for two years from date of entry.

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