Challenger Tech. The new Income and Assets test zones post 1 January December By: Minh Ly, Senior Technical Services Analyst

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1 Challenger Tech December 2016 The new Income and Assets test zones post 1 January 2017 By: Minh Ly, Senior Technical Services Analyst Constructing a client s retirement income is a complex task demanding strategic navigation through a number of unknowns including how long retirement will last. The Age Pension forms a crucial component of retirement income for many clients, so an understanding of how certain strategies can interact with the Centrelink pension means tests is essential. Strategies that interact efficiently with the Age Pension Income and Assets Tests can help boost client entitlements. This can in turn reduce their reliance on other assets and help extend the longevity of their investments. As always, certain strategies will be more effective than others and will depend on which means test is used to determine a client s pension entitlements. Post 1 January 2017 when the rebalanced Assets Test takes effect, the asset ranges where client pensions are determined under the Income and Assets Tests will change. In this article, we investigate how the Age Pension strategy zones are impacted. The strategy zones Centrelink calculates a person s Age Pension entitlement under two means tests the Income Test and the Assets Test with the test producing the lower result used to determine the person s entitlement. Applying an assumption that all assets held are financial assets and deemed under the Income Test, the asset ranges where the Income Test and the Assets Test determines a client s pension can be calculated. Chart 1 details the Income and Asset Test zones today and from 1 January 2017.

2 Challenger Tech December 2016 For example, couple homeowners from 1 January 2017 will be able to hold total assessable assets (deemed) of up to $271,261 and still receive the full rate of pension. If their financial assets are between $271,261 and $402,500, the Income Test would determine their pension entitlement and Income Test friendly strategies may assist in enhancing their pension. Once assets reach $402,500, their pensions will be determined using the Assets Test with pensions reducing to nil once assets reach $816,000. Chart 1: Current and post 1 January 2017 Age Pension Income and Assets Test zones 1 Key observations You will notice that the full Age Pension zone remains unchanged. Singles will be entitled to the full rate of pension with total assessable assets (deemed) of less than $153,908 and couples, $271,262. The higher taper rate reduces entitlements at a much faster rate from 1 January 2017 and as such reduces significantly the asset cut-off threshold (the point where clients will no longer be eligible for the Age Pension). The higher Assets Test thresholds from 1 January 2017 effectively delays when the Assets Test reduces pensions and hence increases the range where client pensions are determined by the Income Test. Some clients who are currently in the Assets Test zone will transition over to the Income Test zone from 1 January Some clients who are currently in the Assets Test zone will transition over to the Income Test zone from 1 January For example, couple homeowners with total assessable assets (deemed) between $315,000 and $402,500 will move from the Assets Test zone to the Income Test zone on 1 January The wider Income Test zone from 1 January 2017 suggests Income Test friendly strategies may play a larger role going forward. If deeming rates increase (currently 1.75% and 3.25%), the Income Test zone will widen further in both directions. Conversely, if deeming rates were to decrease the income zones will shrink in both directions. 1 Based on Centrelink rates and thresholds as at 20 September 2016 and the higher Assets Test thresholds and taper rate from 1 January Challenger Tech page 2

3 The Income Test zone From an advice perspective, clients who have their pensions determined by the Income Test will benefit from strategies that reduce social security assessable income. Strategies can include the use of private trusts with investments in insurance bonds, reducing income payments (where possible) from grandfathered account-based pensions (ABP) and taking lump sum commutations, and reducing deemed income by reducing financial assets. Lifetime annuities can also help reduce assessable income as they are not assessed as financial assets and deemed. Instead, they benefit from having their income payments reduced by the deduction amount when determining assessable income. If the deduction amount is greater than the income payment, no income is assessed. Assessable income = annuity income payment less deduction amount. 2 For example, Ben (single) is planning to retire in January 2017 when he turns age 70. Most of his assets are in his superannuation account which has a balance of $450,000. He doesn t own his home and his only other assets are his car and household effects valued at $10,000. If his asset values remain unchanged and he invests his entire superannuation into an ABP when he retires, his level of assets places him within the Income Test zone and his Age Pension entitlement will be $ per fortnight ($17,993 p.a.). Lifetime annuities can also help reduce assessable income as they are not assessed as financial assets and deemed. If Ben invests $100,000 from his superannuation into a lifetime annuity instead, and the balance ($350,000) into an ABP, deemed income from his ABP would reduce by $3,250 (based on the current upper deeming rate of 3.25%). His lifetime annuity would produce no deemed income and its assessable income would work out as follows: Regular income payment = $5,000 3 Deduction amount = $6,532 ($100,000 / 15.31) Assessable income = $0 (as the deduction amount is greater than the regular income) In this case, the lifetime annuity will help Ben reduce his assessable income by $3,250. This will increase his Age Pension immediately to $ per fortnight ($19,618 p.a.) The Assets Test zone From 1 January 2017, the higher taper rate will reduce a client s Age Pension under the Assets Test by $780 p.a. for every $10,000 of assessable assets above the Assets Test thresholds. Strategies that reduce assessable assets, such as gifting, spending (e.g. home renovations), purchasing funeral bonds and lifetime annuities, can become twice as effective for clients who fall into the new Assets Test zone. When exploring strategies for your clients, it is important to consider both the immediate and the long term outcomes to their retirement savings. Whilst certain strategies may not provide an immediate boost to pension entitlements, their long term outcomes may be more favourable. Strategies that reduce assessable assets can become twice as effective for clients who fall into the new Assets Test zone. 2 Deduction equals purchase price of annuity divided by the relevant life expectancy (based on the Government s Australian life tables). Where the annuity is owned jointly or with a reversionary beneficiary, the longer of the two life expectancies is used. 3 Based on a Challenger Liquid Lifetime quote as at 09/11/2016, regular income option, monthly income payments not indexed, withdrawal guarantee of 75% and includes an upfront adviser fee of 2.20%. Challenger Tech page 3

4 Challenger Tech December 2016 Although Centrelink assesses the purchase price of a lifetime annuity initially, the amount assessed over time reduces by the deduction amount. For instance, although Centrelink assesses the purchase price of a lifetime annuity initially, the amount assessed over time reduces by the deduction amount. How the deduction amount is applied over time depends on the frequency of the annuity s regular payments. If the annuity provides annual payments, the purchase price is reduced by the deduction amount after each year from the date the annuity was purchased. If the annuity provides income payments at least semi-annually, the purchase price is reduced by half of the deduction amount after each six month period from the purchase date. In Ben s example, his lifetime annuity s assessed asset value profile over time is shown in Chart 2. Chart 2: Assessed asset value of Ben s lifetime annuity over time Case study To illustrate the potential longer term outcomes of a lifetime annuity for clients in the Assets Test zone, consider the following example. Brad and Tracey recently retired with $350,000 each in an ABP. They own their home and have $30,000 savings in the bank. Their car and other home contents are worth $50,000. They require income of $60,000 p.a. (around the ASFA comfortable standard for a couple) which is currently being met from their ABPs and the Age Pension. Chart 3 compares their projected Age Pension entitlements over 15 years under their current scenario (blue line) and also under a scenario where they allocate 30% of their ABPs to a lifetime annuity (green line). Challenger Tech page 4

5 Chart 3: Brad and Tracey s projected Age Pension entitlement (today s dollars) Source: Challenger s Age Pension calculator 4 (run on 9/11/2016) Brad and Tracey s pension entitlement is currently determined by the Assets Test and as they draw down on their ABPs to fund their retirement, their assets reduce to a level that places them in the Income Test zone (year 12). As their ABPs produce deemed income, they only achieve the full rate of pension after year 15. In the lifetime annuity scenario, whilst providing no immediate asset reduction, they receive incremental increases to their pension over time as the deduction amount reduces the assessable value of the annuity. This provided them with an additional $21,230 in Age Pension entitlements (today s dollars) over the 15 year period using Challenger s Age Pension calculator modelling tool. A higher pension entitlement also allowed Brad and Tracey to reduce the amount they draw from their ABPs leaving more of their retirement capital invested over the 15 year period. Based on the same modelling tool, this generated a higher portfolio value for them after 15 years an increase of $39,188 5 (today s dollars). Summary Constructing retirement income for clients can be complex as it can involve a number of unknowns. Strategies that interact efficiently with the pension means tests and address some of the many considerations in retirement planning, can provide your clients with significant benefits over the long term. 4 Calculator uses the following assumptions: Brad and Tracey s asset allocation is 50/50 growth/defensive, returns net of fees of 3.65% on defensive assets, 6.25% on growth. An additional platform fee/ongoing adviser service fee of 0.50% p.a. is also applied to their ABP portfolio. CPI is set at 2.5%. Annuity scenario assumes Brad and Tracey maintain their overall asset allocation of 50/50 by increasing their remaining ABP s asset allocation to 71/29 growth/defensive. Their lifetime annuity is based on Challenger s Liquid Lifetime annuity (regular income option) as at 09/11/2016 with a purchase price of $105,000 each, an upfront adviser fee of 2.20%, monthly income payments of $ each with no indexation and a 75% withdrawal guarantee. Centrelink rates and thresholds as at 09/11/ Includes the withdrawal guarantee of the Brad and Tracey s lifetime annuities. Challenger Tech page 5

6 Contact details By phone Challenger Tech (during Sydney business hours) By By fax By mail Challenger Life Company Limited Reply Paid 3698 Sydney NSW 2001 Website Ut qui doles aperspic tese arit rerum cus seque dolorro te et la conse expeles sinctat estiorestrum veliquas que optiori dis ut aut quidem exeria et faccaborem inulla con nitiostiis volorpo stiusam et quatque nestrum fugitae re nosaquiae nust. The information contained in this update is current as at 24 November 2016 unless otherwise specified and is provided by Challenger Life Company Limited ABN , AFSL (Challenger), the issuer of the Challenger CarePlus Annuity. It is intended solely for licensed financial advisers and this update must not be passed on to retail clients. The examples shown are for illustrative purposes only and are not a prediction or guarantee of any particular outcome. The information is not intended to be financial product advice and has been prepared without taking into account any person s objectives, financial situation or needs. Each person should, therefore, consider its appropriateness having regard to these matters and the information in the product disclosure statement (PDS) for the Challenger Guaranteed Annuity (Liquid Lifetime) product before deciding whether to acquire or continue to hold the product. A copy of the PDS is available at or by contacting our Adviser Services Team on This update may include statements of opinion, forward looking statements, forecasts or predictions based on current expectations about future events and results. Actual results may be materially different from those shown. This is because outcomes reflect the assumptions made and may be affected by known or unknown risks and uncertainties that are not able to be presently identified. Neither Challenger nor its related bodies corporate nor any of their employees receive any specific remuneration for any advice provided in respect of the product. Some or all of Challenger group companies and their directors may benefit from fees and other benefits received by another group company. Any taxation, Centrelink and/or Department of Veterans Affairs illustrations are based on current law at the time of writing which may change at a future date. Neither Challenger, nor any of its officers or employees, is a registered tax (financial) adviser under the Tax Agent Services Act and it is not licensed or authorised to provide tax or social security advice. Before acting, Challenger strongly recommends that prospective investors obtain financial product advice, as well as taxation and applicable social security advice from a professional and registered tax agent who can take into account an investor s individual circumstances /1116