SMSF Technical Education & Strategies

Optimising the age pension in retirement

co-authored by Brian Bendzulla (Consulting Actuary) and The SMSF Review

This is the third article in a series that looks at how to fully optimise your retirement income while managing the key risks.

For many Australian retirees today, getting a full or part age pension to supplement their investment or SMSF pension income is an absolutely critical aspect of their financial wellbeing. With it, they have enough total income to live comfortably. Without it they’ll struggle. It’s really that simple.

Whilst there are some limited strategies at the outset of retirement to maximize age pension payments, the vast majority of people will look at what they have in assets, a calculation will be done on what is assessed by Centrelink via both the income and assets test, and an age pension level is determined. And barring any major changes in legislation and / or changes in assets, that’s pretty much as far as it goes.

But is there more to this than many realise?

Rate of drawdown

Consider this. The pace at which retirement assets are drawn down will influence the level of Age Pension entitlements in subsequent years. Maximum entitlements may be obtained by a relatively fast rate of drawdown. A slow rate of usage may result in little, lower (or no) Age Pension entitlement. And on top of this, there is the concept that more assets should perhaps be used in the more “active” (early to mid) years of retirement rather than being spread evenly over time (although there are certainly differing opinions on this).

Death of one member

Now also consider this. On the death of one member, things change dramatically regarding the age pension. This is due to the remaining assets being assessed against the much lower assets and income test for a single person. For many, this can mean they all of a sudden lose their age pension altogether.

So in short - is there an optimal capital usage plan to take account of all this?

The problem with most retirement modeling is that it assumes both members of a couple will either just live to their life expectancy (which creates the problem of longevity risk), or it assumes that both members live to a very advanced age (say 99) which in reality has a very low probability.

The more realistic option for age pension modeling is to allow for a number of years at the couple rate followed by a further period at the single rate. The key here is that this approach requires the level of total SMSF pension payments to be adjusted down on the first death. If the rate for the survivor is dropped to (say) 70% of the couple rate, then for many individuals a larger age pension will result over the years.

It would not be sensible long term to simply draw the desired income regardless of the danger of running out of private assets. A more logical question to ask is what level of income is sustainable? As a maximum, the level of payments that exhausts the assets by average survivorship duration is logical. The resource can be focussed on the earlier years by reducing the planned yearly cost of living increase rate. Some retirees will also want to withdraw some lump sums for planned major expenditure items.

Example:

Lets look at an example to see how this may work in practice:

Consider John and Jan Jones, each aged 66. They have $240,000 and $180,000 respectively in assets. Allowing for mortality improvements, we anticipate that both will be alive for 16 years and that there will be a further 11 years where at least one will be alive.

The next three graphs show for the above durations (if the level of reversion of the SMSF pension is 100% and planned pension increases at 3.00% p.a) what level of income in retirement can be generated, and the sources of that income between private sources (e.g. SMSF pension) and the Centrelink pension.

The above graphs show that the present value (at a 7% p.a earnings rate) of anticipated Centrelink Age Pension receipts is $294,300 versus a total maximum possible value of $420,918.

The Centrelink reductions graph shows that when one member of the couple dies, the reduced thresholds cause a very severe reduction in the Age Pension entitlements. A more optimal pattern of capital usage would introduce a step down when only one person is alive. A level of 75% of the couple level would be suitable. Easing the planned pension increase to say 2% would also assist.

Bottom line

The present value of the Centrelink Age Pension entitlements with this capital usage pattern is $365,089 which is $70,789 more value than the previous strategy.

CLICK HERE to obtain a Tailored Post Retirement Report that deals with how to set a sustainable income level, evaluates future Age Pension entitlements taking into account the issues in this article, and manages the length of life payment duration uncertainty