In the debate around government policy and the age pension, much is made of those people who receive the age pension, and the adequacy of it as a retirement income stream. Similarly, much is made of what is happening to the self- funded retiree as superannuation policy changes. Stuck in the middle is a group that does not seem to be as vocal, but is large in number – those people funding their retirement with a mix of their own investments and some part age pension.
National Commission of Audit figures show that 50% of people in retirement rely on the full age pension, 20% are self funded (receive no age pension) and 30% receive some age pension.
This 30% group is faced with a "perfect storm" ?of low cash interest rates, changing superannuation rules and changing age pension legislation that is making their navigation of retirement particularly challenging.
More punitive asset test coming
The first factor that those people who are receiving a part age pension, or are likely to
receive one once they get to retirement age, need to consider is the looming change to the asset test for the age pension.
Currently, people lose $1.50 of part age pension a fortnight for every extra $1,000 of assets that they have over the minimum asset test threshold, which starts at $350,000 (the assessable amount includes money that may be in superannuation accounts).
From January 1, 2017 the "taper rate" will increase to $3.00 of age pension lost for every extra $1,000 of assets. The impact of this is that people funding their retirement with a mix of their own superannuation and investment assets, and some part age pension, will more than likely receive a reduction in their age pension payments.
Record low interest rates
As part age pensioners see their age pension payments reduce and have to rely more on their own investments and superannuation to fund their lifestyle, it is understandable that they will look to shift some assets into the lower risk asset class of cash.
The problem here is with returns – with record low interest rates it is hard to generate an income from cash investments.
From the January 1, 2017 a home owning couple with $850,000 of investment assets will receive no part age pension. If they tend toward a cautious asset allocation, they might choose to have 40% of their assets in Australian shares and 60% in cash. Assuming a gross yield on the Australian shares of 5.5%, and 2% income from their cash, this income will produce total income of $28,900. This is significantly less than the current amount of age pension for a couple of $34,250 (basic rate).
This leads to some really tough questions for someone in this situation. Do they accept higher volatility to try and increase their portfolio income through exposure to more shares? Do they try and chase a higher yield through some higher risk fixed interest investments? Do they draw down some of their investment capital, and use that to supplement their lifestyle?
What can be done?
Take 3 steps ...
The tough question is – what to do about all these changes? Three key steps seem to present themselves.
1. For those approaching retirement, a focus on making more superannuation contributions earlier becomes more important. This allows the growth assets in the superannuation fund to be providing compounding returns earlier, as well as avoiding some of the restrictions of limited superannuation contributions.
2. An income planning approach to asset allocation, whereby the next five to seven years' worth of income is invested in cash like investments, might help build some confidence about exposing more of the remaining portfolio to growth assets.
3. Finally, modelling the consequences of effectively withdrawing some capital from superannuation assets each year might encourage higher withdrawals earlier in retirement, and then rely more on the age pension later. Of course, the difficulty with this is the possible impact of future changes to age pension rules.