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 |
|
| Reasonable Benefit Limits | 2005-06 |
|---|---|
| Lump sum | $648 946 |
| Pension | $1 297 886 |
Source: Australian Taxation Office: TD 2005/21
Reversionary Beneficiary
The person to whom an income stream is paid upon the death of the person who was first receiving the payments (known as the primary beneficiary).
Reversionary Pension
A reversionary pension is the income stream that a reversionary beneficiary is paid.
Superannuation Pension Tax Offset (or Rebate)
Where a person receives an eligible termination payment and uses it to purchase an annuity or pension from a taxed superannuation fund and the person is 55 or more years of age, the person is entitled to a tax offset, at 15 per cent, on the assessable part of the annuity or pension payment that is not in excess of the person’s reasonable benefit limit.
Self Managed Superannuation Fund
A self managed superannuation fund is a fund:
The overwhelming majority of self managed superannuation funds have one or two members. Because all the members of a self managed superannuation fund are trustees, the fund is not subject to the full range of prudential regulation and supervision requirements.
Senior Australians Tax Offset (SATO)
Certain low income aged persons, both pensioners and self-funded retirees, are entitled to a special additional tax offset. This offset, described in the legislation as the low income aged persons rebate, is generally referred to as the Senior Australians Tax Offset (SATO).
The classes of person eligible to claim the offset are as follows:
In the 2005–06 year the maximum rebate is $2230 for those with tax assessable income below $21 968 p.a. The rebate reduces by $0.125 for every dollar a person’s assessable income exceeds this threshold. SATO is not available to those with tax assessable incomes exceeding $39 808 in this financial year.
Structural Ageing of the Workforce
Australia’s population is rapidly ageing. The share of the population aged over 65 years is projected to rise from 13.0 to 24.5 per cent from 2003–04 to 2044–45. An even bigger relative change is anticipated for the oldest old — those over 85 years. Their share increases from 1.5 to 5.0 per cent over this period.
Currently, there are 5.2 people in the potential workforce for every person aged 65 years or more (an aged dependency ratio of 19 per cent). By 2044-45, this will have fallen by more than half, to less than 2.4 (a ratio of 41 per cent).(3) This trend is the structural ageing of the workforce.
Superannuation
Tax advantaged savings regime that cannot generally be accessed until the member of the superannuation fund has reached their preservation age (55 to 60, depending on date of birth).
Term Allocated Pension
Term allocated pensions will have a similar account arrangement to an allocated pension, but investors will receive payments for a fixed period based on their life expectancy. Other points include:
Australia’s retirement income system is made up of the Government funded, means tested age pension; mandated superannuation savings via the Superannuation Guarantee regime and additional savings, either through additional superannuation savings, or through other vehicles, such as shares, managed funds, fixed interest or property investment.
The superannuation industry has called for better integration of the social security, superannuation and taxation systems. Specifically it has identified several problems:
There have been significant changes in the superannuation, taxation and social security arrangements that affect these issues. The most significant changes are:
Many, but not all, of the Superannuation Industry’s concerns have been met by these changes.
In recent years taxation and superannuation policy has encouraged those approaching retirement, and those in retirement, to maintain their attachment to the workforce. However:
These problems potentially reduces an age pensioner’s incentive to maintain an attachment to the workforce.
Of itself, this apparent lack of financial incentive does not necessarily prevent those over age pension age from engaging in paid employment, as mature workers may undertake work at different times for reasons other than an increase in their overall income.(5) Rather, it points to the potential lack of financial incentives for mature workers, in some circumstances, to engage in paid employment past age pension age.
There have been several calls for better integration of superannuation and private income with the social security system.(6) The aim of this paper is to outline how superannuation, and particularly superannuation-based income streams, are assessed for social security purposes. Some of the problems identified by the superannuation industry in the way this system works are then noted and discussed. In particular the superannuation industry’s concerns about the perceived high effective marginal tax rates are considered. Part of this consideration is the calculation of effective marginal tax rates for a single age pensioner taking into account recent relevant changes to the tax, social security and superannuation regimes.
One of the recent developments of the retirement income system is that it appears to be acquiring a new objective. In response to the apparent structural ageing of the workforce(7) Government policy has shifted towards encouraging participation in the workforce by mature age workers. (8)This paper considers whether the current retirement income system encourages this participation for those over age pension age. It does this by noting some features of the current means test that may discourage those in receipt of age pension payments from participating in the workforce in certain circumstances.
Australia’s retirement income system has three major components:
The interaction between the first component (the age pension) and the other two is crucial to the overall success of this system in providing an adequate retirement income. Taxation arrangements affecting this income also have a large impact on the effectiveness of this system in providing a retirement income.
The age pension is a safety net for those who need income support in retirement. Reaching age pension age (currently 65 for males, 62½ for females), and meeting the required residency requirements does not mean automatic access to the full rate of age pension. About 36 per of those receiving the age pension do not receive the full rate of payments.(10) Rather, their payments are reduced under the provisions of the age pension means test.
Access to the age pension at age pension age is determined by application of the income test and the assets test. Briefly, pension entitlement depends on private income and private assets. A person is paid at the lower of the two rates determined by either the income or the assets tests.
The income test has two stages: a ‘free’ stage where income below a threshold can be earned and the full age pension entitlement still be received, and a ‘tapered’ stage where a person’s age pension entitlements reduce in a graduated fashion. Currently, a couple can receive the full age pension with a combined income at the annual rate of up to $5720 ($220 per fortnight) and a single person can have an annual rate of income of up to $3224 ($124 per fortnight) before their age pension payments start to reduce. Every additional $1 in the annual rate of income reduces both the combined, and single, pension paid by 40c. Entitlement to the age pension ceases once a couple’s combined annual rate of income reaches $57 798 ($2223 per fortnight) and a single person’s entitlement to an age pension ceases once their annual rate of income is $35 379 ($1360.75 per fortnight).(11)
From 20 September 2005 the maximum rate of age pension for a single person is $12 711 per annum ($488.90 per fortnight), for a married couple the maximum rate is $21 226 per annum ($408.20 per fortnight each). The following graph illustrates how the age pension income test reduces a single pensioner’s age pension payments.
For social security purposes income is mostly derived from three sources:
The deeming rates are the rates of return used by Centrelink to determine how much income is generated by financial assets (i.e. shares, fixed interest, bank accounts). They are set at a modest level so that most investment alternatives will produce returns above the deeming rates. The deeming rate is also designed in part to remove the opportunity for pensioners to reduce their private income and increase their pension or obtain the health card and other benefits.
Currently, a deeming rate of 3 per cent applies to:
Currently, a deeming rate of 5 per cent applies to financial investments above these amounts (they include superannuation fund balances and retirement income streams with less than five years duration-discussed below).
The thresholds at which the higher deeming rate begins to apply are indexed in line with the Consumer Price Index in July each year.(12) The deeming rates are adjusted from time to time in line with changes in general market rates of return from all asset classes, at the discretion of the Minister for Family and Community Services.
For the age pension income test, superannuation assets left in a fund are deemed to generate an income. The relevant social security deeming rates are applied to determine the amount of income to be assessed.
If the income stream has a duration of less than five years, income is assessed by applying the social security deeming rates.
If superannuation benefits are taken as an income stream, the payments are assessed under the income test for social security purposes. If the income stream has a duration exceeding five years, the amount of income assessed is that income less an amount that reflects the return of the capital value of the income stream averaged over the person’s life expectancy, or the actual duration of the entitlement, at the date of purchase.(13)
The assets test also has a ‘free’ stage and a ‘tapered’ stage. A home-owning couple (as at 20 September 2005) may have assets valued up to $223 000 (not including their own home) before the rate of pension is affected. Every $1000 in assets over $223 000 reduces the rate of age pension $3 per fortnight, until no pension is payable when the value of their assets reaches $497 500. Non-home-owning couples have asset test limits set $113 500 higher than home owners.
A single pensioner homeowner may have up to $157 000 in assessable assets (again, not including their own home) before their pension entitlement is potentially affected by the assets test. Once their assessable assets reach $322 000 they lose entitlement to the age pension altogether.(14) The following graph illustrates the manner in which a single age pensioner’s entitlements reduce under the assets test.
Superannuation may be included in a person’s asset test assessment. If the superannuation benefits are taken as an income stream, the particular asset generating the income stream may be subject to the assets test, depending on the type of income stream and the date on which it was purchased. Attachment 1 gives a summary of the asset-test treatment of income streams purchased with superannuation benefits, non-superannuation monies or arising from superannuation entitlements in public sector superannuation schemes.
Superannuation entitlements may be taken as a lump sum and used to purchase a host of other assets. Generally they will also be subject to the assets test, but those arrangements are outside the scope of this paper.
The superannuation industry has identified some concerns with the social security means test, as applied to age pension recipients. These are:
The common description of the income test is that a person can receive up to a certain amount of income per fortnight before their age pension payments are affected. But the income test for the age pension operates on the principle of assessing the annual rate of income.(16)
The annual rate of income is the assessed rate at which income is expected to be received, from all sources, over the coming year for social security purposes. It is used to determine a person’s current need for the age pension. It is based on the income produced by financial assets calculated by the application of the deeming rates, plus income expected to be produced by predictable sources of income such as income streams or employment. The assessed annual rate of income is not the same as the actual income received by the pensioner. Nor is it the same as income assessed for taxation purposes.
The annual rate of income method, used to assess a person’s entitlements to the age pension under the income test was adopted because the actual amount of income received during the year is not accurately known until after it has been received. Often there are lengthy intervals between the receipt of a pensioner’s private income, such as the period between dividend payments from shares or the payment of private pension income once a year. Accurate social security pension payments need to be made before this occurs, and the annual rate of income allows Centrelink to estimate the pensioner’s current need for income support so that appropriate social security payments can be made.
Basing a pensioner’s payments on the actual income received would involve complex and intrusive assessments and re-assessments of a retiree’s income several times during the year, or the very politically unpopular recovering of payments already made, should the actual income received exceed the amount on which the pension payments were based.
The adverse impact of assessing earned income for age pension using the
‘annual rate of income method, in assessing income for social security
purposes can be seen in the so called ‘Santa Claus’ decision by the Administrative
Appeals Tribunal (AAT) in 1998. (17)Briefly, some age pensioners
worked as casual Santa Clauses during the December period. They declared
their earnings to Centrelink. This caused their assessed rate of annual
income to increase to the point where they then experienced a significant
drop in pension entitlements for the period they were working. However,
the amount they actually earned over their period of employment, together
with their other income, remained below the annual rate of income at which
no effect on age pension entitlements occurs. The AAT decided in favour
of the pensioners.
The superannuation industry is concerned that this sort of problem points
to the poor integration of the means test rules with the likely sources
of private income in retirement. Further, it is apparent that rules that
appear to work well enough for the assessment of unearned income do not
appear to work well for the assessment of earned income.(18)
The relationship between the income and assets test is also an issue. There is a view in the community that the rate at which pension entitlements are withdrawn under the assets test is too severe and that there should be greater correspondence between the respective withdrawal rates under the income test and the assets test. In particular, it is felt that the rate at which pension entitlements are reduced under the assets test should, at various rates of investment earnings, be the same as the reduction in entitlements under the income test. (19)
An effective marginal tax rate (EMTR) shows the percentage of additional income lost, as private income increases, due to the withdrawal of means-tested benefits and additional income tax payable. A 70 per cent EMTR means that a person is only 30c better off after receiving an extra dollar of private income.(20)
In July 2003 the Association of Superannuation Funds of Australia (ASFA) calculated that a single age pensioner faced 70 per cent EMTRs, mainly where the pensioner started to pay income tax.(21)
ASFA is concerned that a high EMTR discourages savings for retirement, as it considers that those able to save for retirement will not do so if they perceive that their entitlement to an age pension is reduced or eliminated by this additional saving.
Access to the age pension is highly valued by retirees. Consequently, they may make investments with the aim of getting the age pension. This entails purchasing less efficient investments. In this context less efficient investments are those that produce a comparatively low rate of return.
One method of accessing the age pension, in situations where the assets test may restrict this access, is to purchase income streams that qualify for an exemption under the assets test. Until 20 September 2004 one of the qualifications for the exemption was that the income stream payments be backed by a guarantee.
Generally, individuals who wish to purchase these ‘guaranteed’ income streams had to approach large life insurance companies. The income streams are usually backed by fixed-interest securities that reflect prevailing interest rates at the time of purchase. Generally, fixed-interest investments do not produce as high a rate of return over a long period of time and can be seen as an ‘inefficient investment’ according to the above definition.
Because there are significant penalties for exiting these products, the purchaser is more or less locked in to that level of income for the term of the product (either their life expectancy or their actual lifetime).(22) The consequence may be that, while they may get the age pension, or an increased level of age pension, the overall investment income they receive may be lower than if they were to put their capital into assets that provide a higher overall rate of return.
A related problem is that some retirees source these ‘guaranteed’ income streams from self-managed superannuation funds. These funds have more difficulty than the larger retail funds in effectively spreading the risk associated with the ‘guarantees’. To offset this problem, for a given level of risk, those that purchase an income stream from such funds have to commit more capital to obtain a particular level of income, than would be the case for a larger retail provider. In these circumstances, social security payments are being used to support a very inefficient use of the retiree’s capital.
Here, efficient use of capital means the commitment of the minimum necessary to achieve the required outcome. The amount of capital needed to pay a guaranteed income stream from a self-managed superannuation fund is significantly above that required to pay the same income from a life insurance company statutory fund. Thus social security payments were encouraging the inefficient use of a retiree’s resources.
The stability of guaranteed income streams paid from self managed superannuation funds is not of the same quality as guaranteed income streams paid from much larger life-office statutory funds. Asset-test exemption is given to these income streams in recognition that the capital invested has a very high probability of lasting through the expected term of the income stream. This cannot be assumed in respect of every asset–test-exempt income stream paid by a self-managed superannuation fund.
Self-managed superannuation funds paying an asset-test-exempt income stream may also provide estate planning opportunities. This occurs because, on the death of the pensioner, the capital backing the pension stays in the superannuation fund, and becomes available to other fund members for their own retirement. These other fund members will usually be members of the pensioner’s own family. The capital that passes to their accounts in these circumstances has been exempt from the assets test. Thus social security benefits, that might not otherwise have been paid, have underwritten the passing of this capital to other family members.
As part of the 2004 election campaign, the government announced that it would introduce the Mature Age Worker Tax Offset. In the 2005–06 year, a tax rebate of up to $500 will be paid to those 55 years and older with earned income (before tax) of between $10 000 and $53 000 per annum.(23) Unearned income, such as income received from social security or superannuation-based income streams, is not taken into account in assessing eligibility for this particular tax offset. But provided a person qualifies for this particular tax offset, it can be used to reduce their overall tax payable, irrespective of sources of their income.
On 10 May 2005 the Government announced additional changes to the income tax rates for low income earners, and increases in the tax-free thresholds for other taxpayers. Of greatest relevance is the reduction in the lowest marginal tax rate from 17 to 15 per cent for those whose assessable income is between $6000 and $21 600 p.a.
As part of the 2005–06 Budget, the Medicare threshold was increased for those eligible to receive the Senior Australians Tax Offset, to $21 968.(24) Normally, in 2005–06, the Medicare levy starts to apply once a taxpayer’s income exceeds $15 902 p.a.(25)
In addition to these recent measures people of age pension age may also benefit from the Senior Australian’s Tax Offset, the Low Income Rebate, and if they receive a superannuation based income streams containing post 1983 monies, the superannuation pension tax rebate. While not new measures these tax rebates are included in the paper’s calculations for a single age pensioner.
Recent changes in the treatment of income streams under the social security assets test have reduced some of the incentives to purchase low-yield investments.
From 20 September 2004:
Prior to 20 September 2004 100 per cent of the purchase price of an eligible income stream was exempt from the assets test and ‘Market Linked’ or ‘Term Allocated’ pensions were not exempt from the assets test.
From 12 May 2004, self-managed superannuation funds, with limited exceptions, can no longer provide a ‘guaranteed’ lifetime or life expectancy pension. However, these funds can offer market-linked income streams. A Commonwealth Treasury review of these rules has recently confirmed these new rules.(26)
These changes reduce the attractiveness of guaranteed income streams for gaining access to the age pension under the assets test. Therefore, there is less incentive for retirees to invest in products that produce a low rate of return, simply to gain access to the age pension.
In the light of these changes, are the superannuation industry’s concerns still valid?
To date, there is no empirical evidence that those who might make additional contributions to superannuation are discouraged from doing so by the means test. Theoretically, so long as the EMTRs lower the rate of return on investment, there is a prima facie case that suggests the current incentive structure discourages savings. However, it is unlikely that those making additional contributions to superannuation are even aware of this argument, as awareness of retirement income issues is not at all widespread.(27)
A possible major impact of a high EMTR is that it may discourage those seeking to work to earn that extra dollar. This has a significant potential impact on incentives for the participation of older people in the workforce. It can be argued that high EMTRs will discourage older workers from remaining in, or re-entering, the work force, even on a part-time basis.
With the application of the Mature Workers Tax Offset, Senior Australians Tax Offset (SATO) and the newly introduced tax rebates, what are the possible effective marginal tax rates faced by a single age pensioner?
EMTR calculations suggest that single pensioners face high EMTRs at various points, even with the benefit of these tax offsets. The following table shows the EMTR faced by single pensioners who increase their income to these levels:
| Annual tax-assessable income | EMTR |
|---|---|
$15 790 |
40% |
$21 999 |
52% |
$23 075 |
80% |
$23 780 |
69% |
$27 481 |
68% |
$34 560 |
66% |
Source: author’s calculations(28)
If EMTRs are accepted as a valid measure of incentives—or the lack thereof—to participate in the workforce, then current tax arrangements, even after all of the recent changes have been applied, may be a significant financial disincentive to continued participation in the workforce by aged pensioners. This would be true where significant EMTRs apply over an extended income range, as they do in the above example.(29)
However high these EMTRs appear, some additional points should be kept in mind:
The following table shows the average tax rates with the benefit of the Mature Age Workers Tax Offset, SATO and the Low Income Tax Rebate compared with the average tax rates that a normal taxpayer would face during the 2005–06 year:
Table 2: Average Tax Rates—single age pensioner
|
Annual tax-assessable income |
Average tax rate |
Average tax rate |
|---|---|---|
| $15 790 |
0.00% |
9.30% |
| $21 999 |
0.03% |
11.21% |
| $23 075 |
1.02% |
13.02% |
| $23 780 |
2.94% |
14.09% |
| $27 481 |
9.01% |
16.43% |
| $34 560 |
16.17% |
19.52% |
Source: author’s calculations
Although significant EMTRs apply at various points after all the available tax rebates are applied, that does not necessarily lead to the conclusion that they form serious financial disincentives to continued participation in the workforce by mature-aged workers. As the table above suggests, mature workers on low incomes face a far lower tax burden than other participants in the labour market.
The amount of a complying income stream’s purchase price that is exempt from the assets test has decreased, but has not been eliminated. Those with sufficiently high superannuation balances upon retirement will still have an incentive to invest in partly social security asset test exempt products to gain access to the age pension. Consequently, there is still an incentive to invest in these low-yield products.
Over time this incentive may apply to an increasing number of the retired population. As superannuation balances continue to build, leading to increases in the end benefits, increasing numbers of retirees will have a sufficient incentive to invest in asset test exempt products. Generally, retirees are risk adverse in their investment preferences. Accordingly, the number of retirees preferring guaranteed asset test exempt income streams may also increase. This incentive may become compelling during periods of sustained poor investment returns. During such periods retirees may prefer a guaranteed level of payments from an income stream.
The availability of the new Market Linked (or Term Allocated) Pensions addresses some of the investment efficiency concerns, by allowing a proportion of assets that are more exposed to investment markets to be exempt from asset-test assessment. While the superannuation industry’s concerns are met for the moment, the combination for increasing superannuation balances and a significant decline in overall investment returns may increase the proportion of guaranteed asset test exempt income streams purchased solely to gain access to the age pension.
As noted above the ban on self-managed superannuation funds paying a complying guaranteed asset–test-exempt pension has been confirmed. This addresses concerns regarding estate planning funded by the age pension. It also addresses concerns about the over-investment of a retiree’s resources in these products to receive a given level of income.
Self-managed superannuation funds will still be able to pay a Market Linked pension and thereby gain benefits under the assets test. With these products the person’s financial resources may be more efficiently invested (that is, in assets that may well produce higher returns over a longer period), and are simpler and less costly to administer than traditional complying guaranteed asset-test-exempt income streams.
While there is no link between the way the income and the assets tests operate, this is not currently a large problem, as only between 5 and 6 per cent of age pensioners are assessed under the assets test.(32)
As superannuation balances increase, it may be the case that an increasing number of those receiving lump sum superannuation entitlements may be affected by the assets test. However, the tax and social security incentives to purchase a 50 per cent asset test exempt income stream remain strong, and are likely to reduce the rate at which the assets test will impact on entitlements. These incentives will most likely restrict the growth in the number of pensioners whose rate of payment is determined under the assets test.
The method of assessing a person’s pension entitlements under the income test, based on their annual rate of income, allows Centrelink to assess their current need for income support. But it was also introduced, when most age pensioners did not work, and when it was not the Government’s intention to increase older workers’ participation in the workforce.
An income test based on the concept of an annual rate of income does not encourage a pensioner’s participation in the workforce, as earned income is difficult to assess under this type of income test. This is due to:
An alternative approach is to assess the pensioner’s income for social security purposes in these circumstances as $2720 for the whole year and reduce the pension payments accordingly for the next twelve months (in this case there would be no reduction unless the pensioner earned further income). Another example of how this can occur is at Attachment 2.
Following the Federal Court decision in Secretary of the Department of Family and Community Services vs. Rolley (2000), Centrelink is bound to adopt a method of assessing a pensioner’s earned income that will produce the best result for the pensioner. However, implementation of this approach is also subject to the administrative practice of individual Centrelink officers, who may, or may not, be aware of this requirement. A safer course of action would be for further amendment of the Social Security Act 1997 to ensure that a pensioner’s earned income is assessed in a manner that gives them the highest amount of pension payments over the coming 12 months.
However, in the circumstances discussed above a single age pensioner may be reluctant to undertake further employment due to the possible affect on their pension entitlements. Though they may achieve an overall increase in income by doing so, it is possible that the operation of the income test at this point acts as a disincentive to further participation in the work force for the following 12 months.
An unintended side effect of the interaction of superannuation and the age pension is that the purchase of even a modest income stream may actually reduce the incentive to participate in the workforce past retirement age.
This proposition rests on the assumption that mature age workers may not want to increase their income beyond a certain point. Rather, they may simply wish to achieve a certain secure level of income and not further participate in the workforce.
To demonstrate this point, consider the position of a single age pensioner, who has purchased an income stream with a superannuation benefit of $100 000.(33) The following table shows the required amount of before-tax earned income for two pensioners to achieve a level of after-tax income. One is an annuitant (that is, with an income stream), the other has no investments at all (a ‘zero assets’ pensioner). Both pensioners take advantage of all available tax offsets and rebates, including, for the annuitant, the superannuation pension rebate and the pension deductible amount, and are subject to the normal tax rates and Medicare levy.
Table 3. Earned income required to receive a set level of after tax income—single age pensioner
| Required after-tax |
Zero assets pensioner: |
Annuitant pensioner: |
|---|---|---|
| $20 000 |
$10 293 |
$0 |
| $25 000 |
$22 743 |
$2 796 |
| $30 000 |
$36 400 |
$11 130 |
Source: author’s calculations
Obviously, the annuitant pensioner’s incentive to participate in the workforce is a lot less than that of the ‘zero assets’ age pensioner.(34) By the time the ‘zero assets’ pensioner earns sufficient to achieve an after-tax income of $30 000 per year, they are no longer in receipt of the age pension. In contrast the annuitant pensioner still receives some age pension as part of their $30 000 after-tax income.
In the above example, the ‘zero assets’ age pensioner is an unrealistic figure, because there may be a declining number of age pension claimants with few assets. Due to the operation of the Superannuation Guarantee since 1992, the overwhelming majority of age pensioners will retire with some superannuation benefits. The size of these benefits is in dispute, but a recent estimate suggested that the average size of superannuation benefit for 20 per cent of those between 50 and 69 is above $100 000.(35) While some of these amounts may well be used to eliminate debt (particularly housing debt) post–retirement, there will still be a significant number of retirees with both the resources and the incentive to purchase an income stream and commence to receive the age pension.
The recent changes referred to above have increased the complexity of the superannuation and social security systems, even though specific changes have partly addressed particular problems. ASFA has suggested that the complexity of the superannuation and social security systems is a disincentive to save for retirement. ASFA is concerned that people will not save if they cannot understand how they will benefit in retirement.(36)
Despite this assessment there is little evidence that this complexity is acting as a disincentive to save amounts above the mandated Superannuation Guarantee contributions. The recently reported outcome of the Government Co-contributions Scheme suggests that low to middle income earners put additional funds into superannuation despite this complexity.(37) This may be because of widespread ignorance of retirement and social security matters on the part of the working population. However, the Government is attempting to increase financial literacy in the community.(38) A better informed community should lead to better decision making about retirement matters.
A particular challenge is to ensure the public has a correct understanding of the operation of the social security system, particularly that increased resources in retirement do produce a higher retirement income despite the gradual withdrawal of social security benefits.
The calls for better integration of the social security, tax and superannuation systems continue. The changes introduced in the last few years have had the effect of meeting some of the superannuation industry’s concerns and addressing some looming policy problems, especially in relation to income streams paid from self-managed superannuation funds. These changes have also led to a reduction in the use of 100 per cent asset–test-exempt income streams. However, the industry’s concerns over the apparently high levels of EMTRs remain, despite the recent changes to the tax and superannuation systems.
The current system was formulated at a time when most retirees did not work. Further, the aim of Australia’s three-pillar retirement income system (encompassing the accumulation of superannuation benefits) has been to give retirees a higher income than just the age pension alone. The increasing number of age pensioners receiving payments at less than the full rate suggests that this objective is well on the way to being met. But the game appears to have changed. The goal of retirement policy appears to be shifting towards keeping people in the workforce, as well as supplementing the age pension and thereby reducing reliance on the public purse.
The policy objective of increasing the workforce participation rate of older workers increases the need to re-examine the way the social security income test operates. If it is the Government’s intention is to encourage those of retirement age to continue participating in the workforce, there appears to be very little incentive for a retiree with a modest income stream to continue participating in the workforce.
Complying pensions/annuities come in two different varieties, those paid for a person’s life, and those based on a person’s, or partner’s life expectancy at the date of purchase.
There is no requirement to use superannuation monies to purchase asset-test-exempt
income streams. But the majority
are purchased using superannuation balances.
For social security purposes an income stream purchased before 20 September 2004 is asset-test-exempt if the product meets the following conditions:
For asset-test-exempt status, a life expectancy product must be purchased at or after retirement age.
If an income stream is purchased after 20 September 2004, the criteria by which lifetime complying pensions/annuities qualify for a 50 per cent exemption under the assets test are the same as for those purchased before 20 September, with the exception that the ‘guarantee period’ for pensions/annuities purchased after 20 September may be the lesser of the individual’s life expectancy, or 20 years.
Life expectancy and market-linked income stream products may have a term
based on the purchaser’s life expectancy at time of purchase, or the person’s
life expectancy at an age five years younger than their current age. For
example, a person may purchase an income stream at age 65. They may choose
to have a term of that product that is equal to their current average
life expectancy (currently 17.4 years male or 21.15 years female(40)).
Or such a person can choose to have a term for their product that is equal
to their average life expectancy at age 60 (21.66 years male, 25.44 years
female).
If the purchaser is a member of a couple, the term may be based on the
longer of the couple’s life expectancies, or the longer life expectancy
at five years younger. Again for example, say a member of a couple purchases
an income stream when he is 70, but his partner is age 65; he can choose
to have a term for the product equal to his current average life expectancy
of 14.08 years, or his partner’s average life expectancy (21.15 years)
or the life expectancy of his partner at age 60 (25.44 years). This approach
guards against a person outliving their capital where an income stream,
that is not guaranteed to be paid for the whole of a person’s remaining
life, is purchased.
The Government has decided to provide more flexibility to the market linked income stream by extending the term of the pension so that payments can continue until the member reaches age 100 (or until a person’s spouse reaches age 100). Currently the term of the market linked income stream is based on the life expectancy of the member or their life expectancy as if the member was five years younger. (A longer term is possible if the pension is a ‘reversionary’pension.) These changes will apply to new pensions commencing from 1 January 2006.(41)
There are no social security age-based restrictions on the purchase of life expectancy and market-linked pensions/annuities.
Asset values for complying lifetime and life expectancy pensions/annuities
are initially 50 per cent of the purchase price. This amount is depleted
to zero over life expectancy (for lifetime products), or over the term
of the product (for life expectancy products). Asset values for market-linked
pensions/annuities are based on 50 per cent of the account balance backing
the product.
Market-linked pensions/annuities are subject to similar restrictions to
life-expectancy products, but payments may vary up or down subject to
calculation annually in accordance with a specified formula.(42)
| Type of superannuation income stream |
Social Security asset-test treatment |
|---|---|
| Public-sector defined-benefit pension |
100% of purchase price asset-test exempt |
| Complying pension/annuity purchased before 20 September 2004, meeting all requirements in Social Security Act 1991, sections 9A or 9B |
100% of purchase price asset-test-exempt |
| Complying pension/annuity purchased after 20 September 2004, with proceeds of a commuted pre-20 September 2004 asset-test-exempt pension or annuity, meeting all requirements in Social Security Act 1991, sections 9A or 9B |
100% of purchase price asset-test-exempt in limited circumstances |
| Complying pension/annuity purchased on or after 20 September 2004 meeting all requirements in Social Security Act 1991, sections 9A or 9B |
50% of purchase price asset-test-exempt (remaining purchase price is depleted for asset-test purposes over time) |
| Complying market-linked or term-allocated pension meeting the requirements of section 9BA |
50% of account balance asset-test-exempt |
| Allocated pension or annuity (no matter when purchased) |
Account balance fully asset tested |
| Complying pension/annuity that does not meet requirements for asset test exemption in Social Security Act 1991 |
Purchase price fully asset tested (amount depleted over time subject to asset test provisions.) |
Source: FaCS – Guide to Social Security Law(43)
A married age pensioner undertakes a casual job over Christmas serving drinks at a local club. The job lasts four weeks and the pensioner receives $5000. This is the pensioner’s only private income for the entire year. The pensioner understands that he can earn $5720 per 12-month period before Centrelink reduces his and his wife’s age pension payments. However, his payments may be stopped for the time he is earning that amount of money. Or they may be reduced over the next twelve-month period.
Age pension entitlements under the income test are based on the annual rate of income at any one time. They are not based on the amount earned over a year.
Following the Federal Court case Secretary of the Department of Family and Community Services vs. Rolley (2000), Centrelink may assess a pensioner’s earned income in two different ways.
Over the time that the pensioner was working, the couple’s annual rate of income was $65 000 a year or $2500 a fortnight (i.e. $5000 divided by 4 = $1250. Multiply this figure by 52 for the annual rate of income). As this annual rate is way above the current cut-out threshold for a couple ($2275.50 per fortnight or $59 163 a year), their pension is reduced to zero. After the period of employment ends, the couple’s annual rate of income returns to its former level for social security purposes, i.e. zero. The pensioner couple’s entitlement to the full rate of age pension is then restored.
If circumstances warrant it, the amount earned may be treated as the pensioner’s total annual rate of income for the year. Under this approach, there would be no reduction in the couple’s age pension entitlement in this particular case. This is because their annual rate of income (under this approach $5000 for the following 12 months) is below the level at which the pension begins to be affected ($5720)
But if the pensioner’s earnings were, say, $7000 for the four weeks, then under this approach the couple’s pension entitlements would be reduced for the next twelve months. This is because the amount earned is above the rate of annual income at which the couple’s pension payments begins to be reduced.
Centrelink is obligated to choose whichever assessment method gives the
greatest benefit to the pensioner; that is, the one that, taking all the
circumstances of the particular case into account, results in the highest
rate of payments.(44)
The income test works well for those with stable sources of assessed
income for social-security purposes. Such sources include income streams,
where the changes in annual income are predictable, or various financial
investments where the deeming rates used to calculate their income change
relatively infrequently. However, it is more difficult to apply the pension
income test to individuals whose income is subject to significant fluctuations
during a
12-month period, e.g. income from casual employment.
There is sometimes confusion on how exactly to assess a pensioner’s earnings from casual or part-time work, as Centrelink officers have the discretion to choose which of the above approaches applies in each particular case.
CCH 2005 Master Tax Guide, 15–140.
CCH 2005 Master Tax Guide, 15–142.
Productivity Commission, The Economic Implications of an Ageing Australia, March 2005, Ch 2 – Key Points.
ISFA, All about Term Allocated Pensions, Education Fact Sheet, 2004 at http://202.92.75.45/public/content/viewCategory.aspx?id=59#02 accessed 21 October 2005.
Citibank Retirement Index, May 2005, p. 8.
Investment and Financial Services Association Limited, Retirement Incomes and Long Term Savings: Living Well in an Ageing Society, 2003, pp. 10–11. Association of Superannuation Funds of Australia (ASFA), Submission to the Senate Economics Reference Committee inquiry into the structure and distributive effects of the Australian taxation system, July 2003, pp. 20ff. Institute of Actuaries of Australia, Submission to the Senate Select Committee on Superannuation & Financial Services inquiry into Superannuation and Standards of Living in Retirement, June 2002, pp. 17–22. Mercer Human Resource Consulting, The Mercer Response to The Productivity Commission’s Draft Report “Economic Implications of an Ageing Australia”, 23 February 2005, pp. 7–8.
Most recent report on this issue is the Productivity Commission, The Economic Implications of an Ageing Australia, March 2005.
Treasury, Australia’s Demographic Challenges, February 2004 and Treasury, A More Flexible and Adaptable Retirement Income System, February 2004. More recently, The Hon. Peter Costello, MP, Media Interview 24 October 2005:
People are living longer, and we are having less children, so that means that the proportion of older people to the proportion of workforce age people is growing all the time. Now if we are going to make this economically sustainable, we have got to get control on costs, we have got to have a productive economy, and we need to encourage older people to maintain a connection with the workforce, if not full-time, maybe in a part-time capacity longer than they currently do. With people living longer and in better health they have a capacity to maintain a connection with the workforce longer.
Treasury, A More Flexible and Adaptable Retirement Income System, February 2004, p. 1.
Department of Family and Community Services, Annual Report 2003–04, Figure 16 Proportion of Age pension customers receiving a part-rate pension, June 1994 to June 2004.
Centrelink, A guide to Australian Government payments, 20 September - 31 December 2005, pp. 7 and 20.
Department of Family and Community Services, ‘Guide to Deeming’, http://www.facs.gov.au/internet/facsinternet.nsf/aboutfacs/programs/seniors-deeming_guide.htm, accessed 25 July 2005.
See Family and Community Services, Guide to Social Security Law, ‘4.9.2.30 Income Test Assessment of Asset Test Exempt Income Streams’, and FaCS, Guide to Social Security Law, ‘4.9.3.30 Income Test Assessment of Asset Tested Income Streams’.
Centrelink, A guide to Australian Government payments, 20 September - 31 December 2005, p. 19.
ASFA, ibid., p. 18.
See Family and Community Services: Guide to Social Security Law, ‘4.2.1.10 Pensions Income Test & Limits’
Re Department of Social Security and Moroney, (1998) 52 ALD 655.
Private conversation with industry lobby group.
For example, ASFA, op. cit., pp. 18–23.
Gillian Beer and Ann Harding, ‘Effective Marginal Tax Rates–Options and Impacts’, paper presented to Centre for Public Policy Conference on Tax Reform: Directions and Opportunities, 18 February 1999.
Association of Superannuation Funds of Australia (ASFA), Submission to the Senate Economics Reference Committee inquiry into the structure and distributive effects of the Australian taxation system, July 2003, pp. 20ff.
Pensioners can commute their asset–test-exempt income stream at any time, and reinvest these monies in another asset–test-exempt income stream from the same, or a different, provider.
Liberal Party of Australia, The Howard Government Election 2004 Policy: Mature Age Worker Tax Offset, 9 September 2004, http://www.liberal.org.au/documents/Sept09_Mature_Age_Workers_Tax_Offset.pdf. The Government confirmed its commitment to introducing this offset in Budget Statement No. 1, 2005–06, p. 17. The necessary legislative changes were implemented in Tax Laws Amendment (2005 Measures No. 1) Act 2005.
Tax Laws Amendment (Personal Income Tax Reduction) Act 2005, Schedule 1, item 4.
Tax Laws Amendment (Medicare Levy and Medicare Levy Surcharge) Act 2005, Schedule 1, items 4 to 8.
The Hon. Mal Brough MP, Minister for Revenue and Assistant Treasurer, ‘Outcome of the Review of Pensions in Small Superannuation Funds’, Media Release, 27 September 2005.
ISFA op. cit., p.13, and ANZ Bank, Survey of Adult Financial Literacy in Australia, May 2003, p. 7.
Rates as calculated for a single home-owner pensioner under the assumption that private income equals assessed income for social security purposes. This assumption holds true in a limited number of cases, but significantly it is true in situations where earned income is assessed for social security purposes. Medicare levies were included in the calculations.
Craig Emerson, New thinking for a new century: Getting our priorities right in income tax reform, 25 August 2005, pp. 4–5.
Matthew Toohey and Gillian Beer, ‘Is it worth working now?: the financial impact of increased hours of work for mothers under Australia’s new tax system’, National Centre of Social and Economic Modelling, Canberra, December 2003, p. 3 cited in Craig Emerson, ibid, p. 5.
See also Emerson, ibid., p. 5.
Family and Community Services, Occasional Paper No. 7, Income supported customers: A statistical overview 2001, Table 3: Age pension Customers: Characteristics by sex, June 2001.
Life expectancy income stream purchased by a 65-year-old male, 2% indexation at rates current mid-June 2005, with a purchase price of $100 000 in un-deducted contributions. The assumption is that the pensioner only has $100 000 in total superannuation benefits. Since lump sum tax does not apply to withdrawn benefits below $129 751 of post-1983 monies in the 05–06 tax year, the pensioner is assumed to have withdrawn the whole amount and immediately purchased an ordinary money income stream. Source of annuity rates: Plan for Life Limited, published in June 2005 edition of Personal Investor.
Again, these calculations assume that the pensioner purchased a $100 000 annuity with ordinary money. The author’s calculations suggest that the incentive for single pensioners to participate in the workforce, if they have a $100 000 annuity purchased with post-1983 money, is further reduced.
Simon Kelly, Carol Farbotko and Ann Harding, The lump sum: here today, gone tomorrow, AMP/National Centre for Social and Economic Modelling Wealth Report Issue 7, March 2004, p. 6. Significantly, this estimate was based on data from 2003. In 2005 it is likely that more than 20% of retirees have superannuation benefits well over $100 000 in value.
ASFA, op. cit., pp. 20ff.
The Hon. Mal Brough, Minister for Revenue and Assistant Treasurer, $244m Injection into Australian’s Retirement Savings, Media Release, 8 February 2005, and Australian Taxation Office, Reports on Operation of Government Co-Contributions scheme for 2004–05, 24 August 2005.
Consumer and Financial Literacy Task Force, Preliminary Recommendations to Government, 31 August 2004, at http://cfltaskforce.treasury.gov.au/content/home.asp and the Financial Literacy Task Force web site at http://www.understandingmoney.gov.au/ both sites accessed 20 October 2005.
See Family and Community Services, Guide to Social Security Law, 4.9.2.10 Characteristics of pre-20/09/2004 Asset-Test Exempt Income Streams.
Family and Community Services: Guide to Social Security Law, ‘4.9.5.46 Table of Life Expectancy—Payments Commenced on or after 01/01/05’.
The Hon. Mal Brough MP, Minister for Revenue and Assistant Treasurer, ‘Outcome of the Review of Pensions in Small Superannuation Funds’, Media Release, 27 September 2005.
Social Security Act 1991, section 9BA.
Family and Community Services: Guide to Social Security Law, ‘4.9.2 Asset-Test Exempt (ATE) Income Streams’.
Family and Community Services: Guide to Social Security Law, ‘4.3.3.30 Employment Income for Pensioners of Age pension Age’.
