Social Security update

Introduction

This technical update examines the proposed change to the social security and aged care system to make asset test exempt income streams unavailable from September 20, 2007, and the potential benefits of investing in these instruments prior to then.

Assets test exempt income streams become unavailable from September 20, 2007.

From September 20, 2007, the current 50 per cent assets test exemption for complying income streams will be unavailable for new income streams. However, complying income streams purchased prior to this date will continue to receive a 50 per cent assets test exemption if purchased between September 20, 2004, and September 19, 2007. Complying income streams purchased prior to September 20, 2004, will generally retain a 100 per cent assets test exemption.

ING Technical Services continues to receive the following questions in relation to complying income streams.

(i) Can owners of existing term allocated pensions and assets test exempt income streams commute to a lump sum in view of the reduction to the assets test taper rate?

(ii) What is the value of purchasing these products prior to September 20, 2007?

The answer to question (i) is straightforward.

The Government has stated that complying income streams cannot be commuted to a lump sum unless the owner satisfies one of the normal commutation requirements (e.g, commutation within six months of commencement).

However, the answer to question (ii) is not as straightforward and is quite subjective. We will try to answer this by way of case study examples as follows.

Case study 1

Brian (age 65) is a single homeowner with $330,000 in assessable assets. The assets test disqualification limit for a single homeowner is currently $334,250, so Brian is only entitled to a small age pension.

Should Brian purchase a $150,000 assets test exempt income stream, this will reduce his assessable assets by $75,000 to $255,000. The following table provides an estimate of the age pension currently payable and that which will be payable from September 20, 2007. The calculations assume Brian’s assets do not significantly change.

See table 1 Super Review magazine February 2007 page 16.

Brian will be immediately entitled to a very small age pension of $322.40 per annum. However, if he purchases a $150,000 complying income stream, the rate will increase to $6,172 per annum. This equates to an extra 3.9 per cent return in age pension. However, if Brian doesn’t purchase the income stream, he will become entitled to an age pension of approximately $7,762 per annum from September 20, 2007.

The increased benefit, as a percentage compared to the amount invested, is halved to 1.95 per cent from September 20, 2007 (i.e, ($10,687-7,762)/$150,000). Therefore, Brian must decide whether the extra 1.95 per cent per annum return is a sufficient incentive to forgo access to his lump sum for a minimum of 18 years. In fact, the maximum return that anyone will be able to receive (under the assets test) by using a complying income stream will generally be 1.95 per cent per annum (although this benefit may be higher for age care clients — see Case study 3).

However, the percentage benefit is likely to be less than 1.95 per cent per annum the more an individual’s assets exceed the disqualification limit (post 20/9/07).

Case study 2

Kate and Herb are of age pension age and own their home. They have $520,000 in assessable assets. They are currently ineligible for the age pension, as the current assets test disqualification limit is $516,500.

Should Kate and Herb purchase a $250,000 assets test exempt income stream, their assessable assets will be reduced by $125,000 to $395,000.

The following table provides an estimate of the age pension currently payable and that which will be payable from September 20, 2007. The calculations assume the couple’s assets do not significantly change.

See table 2 Super Review magazine February 2007 page 16.

The benefit of purchasing a complying income stream in this scenario is similar to Case study 1. That is, the maximum benefit as a percentage of the amount invested is 1.95 per cent per annum (i.e, ($17,280-12,400)/$250,000), as well as the value of the pensioner concession card.

Case study 3 — Aged care issues

In this case study, we will look at a couple’s position post September 20, 2007.

Scott and Michelle (aged 73 and 65 respectively) are self-funded retirees. While they currently reside in their own home, Scott has been assessed as needing low care (hostel) accommodation. It is assumed that Scott will shortly enter a hostel and pay an accommodation bond of $128,500.

After funding the accommodation bond, the couple’s assessable assets will be as seen in table 3:

What impact will Scott and Michelle’s investments have on any age pension entitlement and aged care fees post September 20, 2007? Would income streams add value?

Option 1 — No income streams

With this option, Scott and Michelle do not use any income streams (i.e, financial investments are preferred). Total assessable assets are $1,000,000, with $950,000 subject to deeming. It is estimated that the “separated due to illness” disqualification limit will be $961,500 on September 20, 2007. Scott and Michelle will not, therefore, be entitled to the age pension.

For effect on aged care fees see table 4 Super Review magazine February 2007 page 16.

Option 2 — Using a $500,000

allocated pension

With this option, Scott purchases a $500,000 allocated pension and selects the minimum annual payment. Of their financial investments, $450,000 remains. Scott and Michelle will not be entitled to the age pension due to the assets test.

For effect on aged care fee sees table 5 Super Review magazine February 2007 page 17.

By using an allocated pension, Scott’s care fees are reduced by $3,140 per annum over Option 1. This is due to the income reducing effect under the income test of the allocated pension when compared to financial investments. This income reducing effect could be further enhanced if a lower payment is selected under the new pension standards, which begin on July 1, 2007.

Option 3 — Using a $250,000 allocated pension and $250,000 term allocated pension

With this option, Scott purchases a $250,000 allocated pension and a $250,000 term allocated pension. The minimum annual payments are selected. Of their financial investments, $450,000 remains.

For effect on aged care fee sees table 5 Super Review magazine February 2007 page 17.

Scott and Michelle also become entitled to an age pension of approximately $4,120 per annum.

By using this option, Scott’s care fees are reduced by $2,200 per annum over Option 2, and $5,340 per annum over Option 1. The total benefit over Option 2, including the age pension of $4,120 per annum, is $6,320 per annum.

However, as a percentage of the amount paid for the term allocated pension, this represents 2.5 per cent. Scott and Michelle must consider whether or not this is a sufficient benefit in exchange for locking away access to their capital in the term allocated pension. Another option could have been purchasing an ordinary money complying annuity with the non-eligible termination payment funds to further reduce assessable assets. However, it is important to note that aged care clients generally have a lower life expectancy compared to the rest of the population (e.g, average life expectancy for nursing home residents is 36 months), so the likelihood of the annuitant dying before the end of the relevant term is significant. Consequently, the potential for a reduced payout amount on the annuity due to early payment should be taken into consideration.

Conclusion

Allocated pensions (and income streams under the new pension standards from July 1, 2007) may significantly reduce income-tested fees (when compared to similar amounts invested in financial investments).

Complying income streams may provide increased levels of age pension if purchased prior to September 20, 2007. However, this benefit will be reduced from September 20, 2007, due to the reduction in the assets test taper rate.

It is important to note that while complying income streams may have an income reducing effect when compared to financial investments, allocated pensions (and the new July 1, 2007, pensions) generally provide a greater income reducing effect (where minimum payments are selected) and, therefore, may result in lower income tested fees.

Clients will therefore need to determine whether or not the purchase of a complying income stream prior to September 20, 2007, will add sufficient value in exchange for the loss of access to capital.

George Avramedes is technical services manager, ING Australia.