Why pensioners are cruising their way around budget changes 36



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Age pensioners have always gone on cruises. But since the budget, we have seen stories emerge of age pensioners changing their behaviour in response to the proposed rebalancing of the age pension asset tests.

Sydney housewife Noelene has bought a holiday cruise to Alaska. Seemingly contradicting sensible living strategies for many older people, financial advisers are now proposing part-pensioners upsize and buy a more expensive house.

It’s surprising behaviour, especially in light of new research from CePAR using government data that demonstrates many age pensioners actually live very frugally. Many pensioners live below even the “modest” retirement standard proposed by ASFA ($23,469 for a single and $33,766 for a couple, who own their own home). Indeed, many pensioners are cautious and keep a cushion of assets, whether because of concern about risk, to pay for age care when frail, or to leave a bequest to children or grandchildren.

What’s changed

Why would age pensioners choose to spend big now? Well, it’s a rational response by part-pensioners to the proposed budget asset tests. If the anecdotal behaviour is writ large, a lot of the potential revenue gains (estimated at A$2.4 billion over 5 years) from the asset test changes may disappear.

Apart from the home, the financial and other assets of age pensioners are tested above a limit, so as to target the pension. The age pension is also subject to an income test. At the moment pensioners are assessed under both the income test and the asset test: whichever test gives the lower pension rate is applied. This allows considerable scope for sophisticated pension planning.

The 2015 budget includes changes to the age pension asset tests which deliver benefits at the low end but which are quite draconian for those who have accumulated some assets.

For homeowners, the asset free areas are to rise from $202,000 to $250,000 for single home owners and from $286,500 to $375,000 for couple home owners, but the asset test taper rate will double, from $1.50 per fortnight ($38 a year) per $1,000 to $3 per fortnight ($78 per year) per $1,000.

Pensioners who do not own their own home – and who are much less well off than those who own a home – will benefit from an increase in their threshold to $200,000 more than homeowner pensioners.

On a superficial view, these seem like reasonable changes. But they may have significant behavioural effects and there could be a better way to achieve the government’s policy goals.

Savings taxed: how the government is changing behaviour

The age pension can be thought of as a universal payment combined with an in-built income tax (the income test, which has a 50% tax rate up to the cut out point) and an in-built wealth tax (the asset test).

The effect of the change in policy is to reduce the asset cut-out point where the age pension ceases. Under current asset taper rules, the effective wealth tax rate in the asset test is 3.9% above the threshold. The budget proposal of a taper of $3 per fortnight per $1,000 implies a wealth tax rate of 7.8% ($78 per year per $1,000) above the new thresholds. With real returns of around 5% on many investments currently, the wealth tax effectively confiscates the whole of the real return above the thresholds.

A home-owner couple will see their pension cease at assets of $823,000 compared to over $1.1 million currently. But this home-owner couple with $823,000 in savings would not necessarily have a higher living standard than a home-owner couple with $375,000 in savings; indeed, it could well be lower.

Overall, under the proposed new system, income from savings would be very heavily taxed. Assuming a return to savings of 5%, the effective marginal tax rate could be as much as 160% (the wealth tax rate of 7.8% divided by a 5% return). This creates a disincentive to save. For the conservative investor the situation is even worse, as products like term deposits offer rates only slightly higher than inflation.

An alternative approach: deeming an income return

The Henry Tax Review and the Shepherd National Committee of Audit both recommended that the separate age pension asset test should be replaced by a comprehensive means test that deems income from assets.

A deeming approach disregards actual income from an asset. Only deemed income is included, based on a sensible choice of rate of return, such as the return on bank interest. At 1.75% and 3.25% rates, this is quite a conservative rate of return.

In fact, we already deem income returns in the current pension system, for assets including bank accounts, term deposits, shares, managed funds, loans to family members and superannuation funds (if you are age pension age).

Widening the deeming rules would return us to the “merged means test” which operated in Australia up to the 1970s. Under the test, all assets apart from the home were deemed to yield 10% per annum and actual income from assets was disregarded. The assumed yield on an annuity purchased at age 65 was 10%. Currently an indexed annuity at that age would yield around a third of that in real terms, and even a “growth” investment strategy will yield only 5% to 6%, so a deeming rate around 6% could be justified.

Deeming rates can be set to achieve the sort of budget savings sought by the government with fewer issues for fairness and perverse incentives. A deeming rate of, say, 6% combines with a pension taper of 50% to give an effective marginal wealth tax rate of 3%. This is much less than the effective 7.8% wealth tax rate in the budget measure.

Deeming allows a pensioner to have either modest income or modest assets but not both. It does not unfairly advantage those who maximise their entitlements by planning under both income and asset tests, as the current system allows. A wider deemed base could save as much at a lower effective wealth tax rate than that proposed by the government.

The bigger picture

Australia has highly generous tax concessions for retirement saving, but quite harsh treatment on the pension side. Why incentivise savings through super tax breaks and then penalise savers under the means test?

Home owner retirees are much better off than those who do not own their home and the age pension means test does not touch the top cohort of superannuation savers who receive a hugely disproportionate share of superannuation tax breaks. In contrast to most middle income savers who eventually need some level of age pension with its implicit wealth tax, the top cohort who don’t need the age pension are never subject to any wealth or bequests tax.

The Conversation

David Ingles is Senior Research Fellow, Tax and Transfer Policy Institute, Crawford School of Public Policy at Australian National University.
Miranda Stewart is Professor and Director, Tax and Transfer Policy Institute, Crawford School of Public Policy at Australian National University.

This article was originally published on The Conversation.
Read the original article.

David Ingles and Miranda Stewart

Dr David Ingles has a BEc (Sydney), MEc Sydney and PhD (Public Policy, ANU). He has worked in the Commonwealth public service and also for the Queensland Government in research and policy advisory roles, and was a policy adviser to Ministers in the Hawke Government. He has recently been attached to the Australia institute. He specialises in tax and social security policy. Miranda Stewart is a Professor and Director of the Tax and Transfer Policy Institute at Crawford School of Public Policy, The ANU. She is also a Professor at Melbourne Law School, University of Melbourne. Her numerous edited or coauthored books include Not-for-Profit Law (2014, with O'Connell and Harding, Cambridge U Press); Tax, Law and Economic Development (2013, with Brauner, Edward Elgar); Housing and Tax Policy (2010: Australian Tax Research Foundation) and Death and Taxes (2014, with Flynn, Thomson). Miranda was a consultant to the Henry Tax Review on housing and has authored many articles in national and international academic journals. She is currently researching tax in a global economy and institutions of tax reform.

  1. A lot of doom and gloom reported before budgets is media hype. I work with aged pensioners who still live in their own homes and we talk about how they manage. They don’t have any complaints about the pension, but then they don’t smoke drink gamble.
    One lady who rents told me she saves $200 a fortnight. Hope I can do that when I get to full pension.

    1 REPLY
    • Try saving that when you have to pay council rates and building/contents insurance or registration for a car. Lots of people don’t have access to public transport either.

  2. Poorer Pensioners struggle, those without big super payouts barely get by, those with some money in the bank are spending to get rid of that money so they can get the pension, since I am not in the position of having huge amounts of money, I can only speak for myself and say life is a struggle but one I felt a lot better about before This Abbott Government.

  3. I manage quite well on my pension too but the one thing I have a issue with is the deeming rate. I have just spent a few days researching interest rates so that I can maximise the small amount of savings that I have. I have only recently retired (had not planned to retire at 65 but had to due to a workplace injury). I had my savings in an account that paid a higher interest rate for 3 months. However, I couldn’t find this rate again. The best rate I could find was approx. 2.85%. The deeming rate (I understand) is 1.75% on first $48,000 and 3.50% on over that amount. I could not find anything giving 3.50%. Surely the deeming should reduce when the RBA reduce the cash rate.

  4. Retiring in the next six months and I am confused every time I read items like this, only definite thing I know is we do not have enough tucked away to survive

  5. There have always been ways to get around things if done early enough, been going on for many years. NO Government has tracked a persons assets etc. for years, always been a time frame . Changes won’t concern me. Cruises are cheap if you pick right ship.

  6. I am angry that this government has reneged on their promise to not change the rules around superannuation (despite their protestations that the changes affect only the age pension assets test and taper rates, these changes impact on everyone with a superannuation balance between $375,000 and $823,000). As explained in this article, this ‘middle group’ are effectively taxed on their superannuation balance at a rate of 7.8% (through a reduced entitlement) and we cannot possibly recoup that amount from investment earnings unless we pursue a high-risk investment strategy. That said, the government has selected a soft-target because we don’t have the numbers or influence to impact on their bid for re-election, nor can we afford to have lunch with the Treasurer to put our case for a fairer treatment of superannuation tax concessions that unfairly benefit the very wealthy who would never have qualified for a pension in the first place – they can still enjoy their pension payments on a 0% tax rate. The other very clever strategy of this government is to divide and conquer – we are shown to be parasites who want to ‘suck off the public teat’ at the expense of less well-off pensioners when that is not the case at all. Speaking for myself, we have followed government advice (still on the ASIC Moneysmart website for those that are interested) and built up our superannuation balance so that we could enjoy a more comfortable retirement lifestyle. I am very grateful for the fact that we have had the health and means to do that and I understand that many have not had that advantage. What frustrates and angers me about these proposed changes is that they will remove the incentive for the 50’s age group to save and offset future demands on the pension because there is no point. This is bad policy, the consequences have not been thought through and for me personally, everything we thought we were working towards for the past 10 years has been thrown out the window. I wholeheartedly endorse the need to reduce super tax concessions to those who need them the least. By redistributing the superannuation tax concessions to those households who are most likely to qualify for the age pension at retirement age, we can help them to grow their super balance and reduce pressure on the age pension and future government expenditure. This initiative needs to be fully explained so that everyone is aware how changes to super tax concessions will be targeted and how the whole country will benefit from these changes.

    1 REPLY
  7. And then they wonder when there’s cyclones and floods pensioners don’t have insurances! How the hell can they. Anyone who thinks a pension is overpaid is a moron they worked most of there life building this country and they need to be looked after. Start targeting centrelink and get the people who have never worked a day in there lives and still continue to breed kids with second generations that thinking the government owe them a living!!!!!!!!

    2 REPLY
    • I agree but its the 4th generation with no one working in a household.. they need to do away with the unmarried mothers pension when they have 2 kids… they just live off the government’s hand outs..

    • 100% agree sick of people saying pensioners shouldn’t expect anything well when you work your entire life to pay taxes for people who will never work that’s not fair, baby bonus, first home buyers grant, family tax benefits and 3rd & 4th generation unemployed that’s what’s wrong they all expect the handouts.

  8. Take more from people who take drugs then fools take and steal from pensioners so pensioners are getting least all round

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