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Millionaire Pensioners

June 19, 2006
Millionaire Pensioners
By Scott Francis

PORTFOLIO POINT: Three recent changes to superannuation make it easier for retirees to have assets of more than $1 million, apart from their home, and still qualify for the pension.

It might not have been the Government's desired outcome in the latest sweeping reforms to superannuation, but access to pensions just got easier. Better still, you can still have assets worth up to $1.5 million and tap into more pension money than ever before. At the heart of the new changes is a 50% cut in what's known as the reduction rate, the rate that's applied to means test your rights to government pensions.

Of course, it's not simple, but by the standards of our superannuation system the million-dollar pension is relatively straightforward and hinges on you taking out a complying pension before September 20 next year.

Three important recent developments have allowed this to happen:

1. The introduction of complying income streams with a 50% asset test exemption (such as a term allocated pension).
2. The proposed introduction of changes to the pension taper, which reduces the rate at which people get access to the age pension
3. The introduction of transition-to-retirement regulations

The sub total of all of this is that people with up to $1.5 million in assets, plus their own home, could still be eligible for a part age pension and the associated benefits.

So how does this all fit together?

Change 1: Complying income streams

Complying income streams, such as term allocated pensions, pay an income stream to an investor over a period of time. Complying income streams are at the heart of the "million-dollar pension" plan.

Before you jump the gun, note that complying income streams are restrictive in relation to how much income is paid each year, providing little flexibility in varying the income from year to year to meet the investor's needs. There is also little opportunity for lump sum withdrawals from a complying income stream; basically the capital invested in the income stream is gone forever.

On the other hand, the key benefit of these income streams is that the assets held in a complying income stream are subject to a 50% reduction for the purposes of the Centrelink assets test. A person who invests $500,000 in a complying income stream only has $250,000 of this counted for the Centrelink assets test.

The proposed superannuation changes allow complying income streams to continue to be started up to September 20, 2007.

Change 2: The proposed introduction of changes to the pension taper that reduces the rate at which people get access to the age pension

The proposed superannuation changes include a change to the rate at which the assets test reduces access to the age pension. The fortnightly age pension now reduces at a rate of $3 for every $1000 of assets over the threshold. The proposed reduction rate is $1.50 per $1000 of assets over the threshold. There is also an income test that potentially reduces access to the age pension, however most retirees find that they are caught under the assets test and not the income test.

The combination of a complying income stream, which reduces the value of your assets for Centrelink purposes, and the proposed reduction in the rate at which the age pension tapers out, is a powerful combination that will allow people unprecedented access to the age pension.

This change to the assets test is proposed to start from September 20, 2007.

So, should everyone immediately retire when they pass the age, currently 55, at which they access superannuation? They don't have to, because the transition-to-retirement regulations allow them to start a complying income stream straight away.

Change 3: Transition-to-retirement regulations

In July last year transition-to-retirement regulations were introduced to allow a person who had reached their preservation age (55) to take some or all of their superannuation benefits in the form of an income stream while still working. These income steams included the use of a complying income stream such as a term allocated pension.

The proposed superannuation changes allow for a person to take a complying income stream under transition to retirement legislation until at least September 20, 2007.

Putting this all together

People aged over 55 are able to invest in a complying income stream even if they are still working. This will reduce the assets of the income stream by 50%. This, combined with the more gradual phasing out rules for the Centrelink assets test, allows people with significant assets to access part of the age pension and the related benefits.

Of course, now that the person who is working is receiving income from a complying income stream, they are able to salary sacrifice even more of their income to superannuation, continuing to improve their superannuation position. (This "round robin" approach might seem odd at first glance, but it is not uncommon among superannuation investors.)

Take for example, a couple who are aged 65, own their own home and are at the point of retirement in September 2007. Assume they have both amassed $400,000 in superannuation assets. At retirement they opt for an allocated pension and choose to draw down their assets at a rate of 6% of their account balance a year, thinking that this is a sustainable draw-down rate. They would each receive $24,000 a year and, under the proposed superannuation changes that sees all superannuation withdrawals for people over the age of 65 tax-free, they would pay no tax. The $800,000 in combined assets means that they are over the threshold for the age pension asset test.

However, let us consider what happens if they each invest $350,000 of their $400,000 superannuation assets in complying income streams, with the other $50,000 invested in allocated pensions. The reason for investing $50,000 each in an allocated pension is that this income stream is far more flexible in allowing lump-sum withdrawals, which will provide their financial situation with greater flexibility.

Their assets for the asset test are now $450,000, being the two $350,000 complying income streams (discounted by 50%) and the two $50,000 allocated pensions. In considering the assets test we also have to add the value of household items and cars, so let us assume that these total $30,000. They have a total of $480,000 for the assets test. Under the assets test they would receive another $449 a fortnight of age pension, or an extra $11,670 a year, plus other related Centrelink benefits. They will still receive this tax-free, effectively increasing their income from $48,000 to just under $60,000.

While I have not included the calculations for the income test, most of the $48,000 is not counted as income under the Centrelink income test, because it is considered a "return of capital" from the purchase of the complying income streams and allocated pensions.

In this case they did not use the transition-to-retirement rules to start their complying income streams while still working. This opportunity is important to people who are currently working and think that they may be able to access age pension using the 50% age pension asset test exemption for complying income streams, because these will only be able to be started prior to September 20, 2007. They are able to start these income streams now, continue to work, build up their other superannuation assets and retain the 50% asset test exemption on the assets invest in a complying income stream.

If you turn 55 in the next 12 months or are older, and are likely to have assets of up to $1 million as a single person or $1.5 million as a couple at retirement (excluding your home), then you may have a surprising ability to use this strategy.

While we await the final outcome of the Government's proposed superannuation changes, due over the next few months, a current reading of the proposed changes would allow the strategy discussed in this article. This is a strategy that you should be aware of, and consider its usefulness to you once the final superannuation changes have been announced.