In 2019, after a new taper rate for the Age Pension assets test took effect, economist Sean Corbett wrote about the retirement income sweet spot and looked at issues around balancing private retirement savings and assets with the Age Pension to achieve an optimal annual income. He revisits that issue and explains why the retirement income system, which comprises both superannuation and the Age Pension, still contains disincentives for retirees who wish to save more super to provide a more comfortable retirement.
•••
The compulsory superannuation system was designed to ensure that people saved throughout their working lives to “provide an income in retirement to replace or supplement the Age Pension”.
For baby boomers (those born between 1946 and 1964), the system has not covered their full working lives (40 to 45 years) and started at only 3 per cent of wages compared to the current rate of 11 per cent with legislation in place to increase that to 12 per cent by 2025.
Australians retiring now, and over the next 20 or so years, have not had a chance to accumulate the amounts the system was designed to deliver.
This shortfall in accumulated savings, coupled with increased longevity and current low interest rates on safer investments such as cash and fixed interest deposits – which retirees tend to favour – means that many baby boomers are finding it very hard to fund a comfortable retirement.
Compounding this difficulty are tougher voluntary contribution limits that have been imposed in recent years, which make it harder to contribute much more to super than the compulsory amount.
Even if people wanted to find a way around these restrictions, the taper rate, which increased the rate at which Age Pension entitlements were reduced as more was saved in super, and increased taxation on retirement savings – brought about by the introduction of the pension transfer balance limit, currently at $1.9 million – provide disincentives to save more super for retirement.
How the taper rate was changed
The changes to the taper rate made in 2017 increased the rate at which the Age Pension is reduced if more assets are held, including assets in super, and exacerbates the disincentive to save more super or invest super more wisely to grow your super.
Until 2017, fortnightly Age Pension entitlements were reduced by $1.50 for every $1000 of assets above the threshold. The rate of reduction since 2017 is double that – $3.
This has resulted in some perverse outcomes across a wide range of super balances at retirement.
Before I look at the outcomes, I will put those retirement balances in perspective. Super savings of $500,000 can be expected to provide an income that keeps up with inflation of around $25,000 per annum, or about $500 a week, for around 26 years with the sort of conservative investment approach that most retirees favour.
Super savings of $1,000,000 can be expected to provide an income that keeps up with inflation of around $50,000 per annum, or about $1000 a week, for the same period of time.
To put that time frame in perspective, a person who is 65 now is expected to live, on average, for around 20 years if they are male and for more than 22 years if they are female. And that is the average, which means that 50 per cent will live for longer.
The surviving member of a couple would on average be expected to live for quite a bit longer. And if emergencies such as medical expenses or the need to go into aged care force people to dip into their super savings, then they will either be forced onto a lower income from their super or their income from super will run out sooner.
To add further perspective, if a person wanted to use his or her super savings to buy a retirement income for themselves and a partner – one that was guaranteed and equal to the couple’s Age Pension – it would almost certainly cost them over $1.2 million.
Going back to the outcomes of the 2017 changes, let us compare a person with $500,000 of super who initially withdraws $25,000 per annum and indexes it over time to keep up with inflation with someone who does the same thing but starts with $1,000,000 in super and initially withdraws $50,000 per annum and indexes it over time.
Both are aiming to make their super last for 26 years, which provides a small buffer above the average time they are expected to live.
The outcomes below are based on Age Pension rates and thresholds from September 2023 and the deeming rates in place at the same time.
The results are for a person who is part of a couple who own their home and have no other assets other than super. I have made a number of reasonable assumptions about such things as wages growth.
Does $1m in super guarantee you a better lifestyle?
Weirdly, one of the outcomes is that the total income (Age Pension and income from super) will actually be higher for the person with $500,000 of super than for the person with $1,000,000 of super during the first seven years of retirement. And it will be more than $13,500 higher in the first year ($65,144 versus $51,581).
In year eight, the person with $1,000,000 of super will enjoy around the same income as the person with $500,000 of super, after which the person with $1,000,000 of super will progressively enjoy a higher and higher amount of total income.
However, it will not be until the 17th year that the person who starts with $1,000,000 will reach a point where their income exceeds that of the person who started with $500,000 by $25,000 – the amount equal to the additional $25,000 they withdraw from their super every year. This only occurs once their super balance falls low enough so that both people qualify for the full Age Pension.
If you look at the total income each person received during the first 25 years of retirement, the person who started with $1,000,000 will only receive around an extra $279,000 of income compared with the person who started with $500,000.
This means that only 56 per cent of the additional $500,000 of super they started with will be returned to them as additional income over the first 25 years of retirement.
I would suggest that the rate at which the Age Pension is reduced under the assets test should be changed back to the rate that applied before 2017.
If that were done, the person who started with $1,000,000 of super in the example above would not live on a lower income compared to the person who started with $500,000 of super in any year of retirement. In addition, they would receive back 79 per cent ($393,000) of their additional super savings as extra income during the first 25 years of retirement.
A warning about your super and tax
I’ll just leave you with a warning, which is that the disincentives to having more super that have been created by the changes to the taper rate in 2017 pale into insignificance when compared to recent attempts to extract more tax from retirees using super to provide an income in retirement.
Both of the major parties now seem to be committed to undermining the super system by extracting more tax from retirees using super. This will inevitably lower the retirement income enjoyed by all retirees, despite attempts by both major parties to portray their changes as only affecting a relatively few people who they characterise as ‘rich’.
Make no mistake, the changes will reduce the retirement incomes of all Australians over time, whether they are ‘rich’ or not, but perhaps that is an explanation that I can provide at another time.
Do you understand the taper rate and the interplay of super with the Age Pension? Are you concerned that the major parties are eyeing super balances with a view to making a tax grab? Share your views in the comments section below.
Also read: Retirement worries hit a 10-year high, new research shows
Sean Corbett has more than 30 years’ experience in the Australian superannuation industry, principally in the areas of product management and product development with a focus on retirement income products.
Disclaimer: All content in the Retirement Affordability Index™ is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.
Sean thank you for this article and I fully support your suggestion that the taper rate needs to revert to the former crate to avoid outcomes that I would describe at the very least as “perverse”, and if I were in a bad mood I’d call them “ridiculous”. (I’m a retired actuary btw and I’ve co-authored several papers on retirement incomes with professional colleagues).
Take note, please, Dr Chalmers: you’re a very intelligent man, but I suspect that fixing this glaring anomaly isn’t a focus for the time being. But how can it be that we have a retirement incomes system that significantly incentivises people who have “more money” than Sean’s “sweet spot” to a home upgrade or renovations that they don’t want or need?
*revert to the former rate
Agree!
Not gonna happen!
The sweet spot is something future retirees should be looking at.
They squirrel away every penny for a retirement, but they don’t realise in old age that the extra money isn’t as important .
Most old people late 70s & 80s ( if they get that far , AND most don’t ) don’t really spend money like they thought they would. They get old & miserly….live on biscuits , soups & cups of tea since their teeth have likely fallen out.
They slow down…don’t have the energy anymore , basically just existing . I’ve known people in very good financial positions only shop at Aldi for the specials , wear clothes that should have been thrown away ages ago, never go anywhere …..it’s simply a lack of motivation & energy that comes with old age.
It will happen to us all assuming we live that long. The saddest thing is when an old person enters the doors of a Retirement/ Nursing home ……they know that’s the end game & did they do the things in life they probably should have , cause it’s too late now. They only leave one way , feet first in a blue body bag.
As a former financial planner , I’ve seen this pattern develop. Personally , I retired at 50 . You don’t have to be a Millionaire, just live like one.
No prizes yet for being the wealthiest guy in a pine box. The best form of wealth is contentment .
.you know you’re getting old when the next pair of shoes you buy will likely see you out, or you don’t need a toothbrush anymore.😆😆
So spend it while you’re able to enjoy it.
LOL, I m debating whether I should buy a new car or not?
Australia, where it pays not to have made an effort!! Thank you Sean. the other risk is when one of us is gone and the asset limit reduces!
Yes, but no. It pays to make an effort to have the max in assets that still allows you to claim the full Aged Care Pension. .
Sean,thankyou so much for your wise and succinct article.
Thankyou also to those who contributed.
The assets test is unAustralian and just a case of more elder abuse ,in the form that the 2 cigar smoking Libs introduced the taper rate change as it affects those whose partners are the sickest of the sick and living in a nursing home.
I lobbied as best I could to explain this to the liberal Party but because Agedcare and pensions are so difficult to understand I felt like I was talking to a blank wall.
Hence by changing the taper rate and not grandfathering no change to those who have already set up their financial affairs it has made life harder for the sick and partner separated by illness.
Labor said lots at the last election but unfortunately the committee set up by Minister Wells is dominated by Owners / Managers /those with links to facilities who talk thru an Industry Association or individuals who are financiers.
COTA is the sole voice for the customer and they present as best their resources Can deliver.
Where is the Seniors customer people on the Committee? Ian Henche maybe.
This Committee is a set up to deliver how to fund Agedcare,not asking the Homes how than can “do it better. Corporate Australia is now all about the shareholders and not the customer.
Cheers.
Wonderful talking points.
Yes the ‘more comfortable retirement’ mantra changes when you factor in the cost of an Aged Care Facility and how that impacts upon those who have saved their entire working life versus those who have spent all their money and then get it all for free, plus the full AP.
Let’s not quibble over a few dollars but look at this globally to make a point.
A couple with No Super or $$s, who Own their House get $43,000 in Aged Pension Plus a few grand in benefits.
Ditto Super and $$$ of $500,000 get income of $25,000 plus $43,000 from Aged Pension = $63,000 plus benefits.
Ditto Super and $$$ of $1m get income of $50,000 and no Pension no AP benefits.
Who gets more income? Nothing wrong with $1m in Super but get rid if it before or quickly at Pensionable Age … for a more comfortable retirement.
Now factor in, Pensioners with no assets get free Aged Care accommodation.
Those with $500,000 get some $$ benefits when entering an Aged Care Facility.
You guessed, those with $1m pay through the nose to enter an Aged Care facility. Opps, there goes your Super savings overnight!
That Super money, if you don’t know your maths, might cost you dearly! And all those holidays and luxury items that you denied yourself over your working like to save that $1m in Super …. Will start to evaporate when you go to an Aged Care Facility.
Yes, there is nothing wrong with $500,000 in Super for a better retirement but after that, who is the mug saver for a more comfortable retirement?
On top of that, who didn’t lose about 50% of their Super money when the Great Financial Crash happened?
Next, there will be a Tax on Super savings! It has to happen! I can’t wait for a percentage of your home to be an assessable asset for the Aged Pension. I have a brick house, but I can’t eat a brick.
The Government frequently changes the Super rules. So much for Financial Planning???
And of course there is the Death Tax of 15% on any unused Super money.
This promise of ‘a more comfortable retirement so save $$’s in Super’ maybe nothing but ‘fools gold’ for some’ …not all, but some!
Don’t blindly save $$’s during your working life but know why you are saving and how that will impact upon you in retirement.
Super does have a sweet spot, but after that, it becomes a bit sour!
Your calculations refer to couples. If you are single and have $500K in super, you get very little pension. And there are many single people out there who would be in this situation. Try living on $25K plus some token pension. My annual expenses before I even buy a coffee are around $15k and going up rapidly every year. That doesn’t factor in anything like house or car maintenance, clothes or appliance replacement.
Agreed but this article has the same assumptions:
“The results are for a person who is part of a couple who own their home and have no other assets other than super.”
You state, “ If you are single and have $500K in super, you get very little pension.” Exactly my point, that $500,000 is not the sweet spot for retirement. Gotta do the maths.
The best rort are couples who get divorced and live in the same house … they both get the single Aged Pension in ‘certain’ circumstances. You just gotta know how to play the game.
We have now found ourselves in this so called “ sweet spot” not necessarily by choice as we had to relocate from FNQ to the Sunshine Coast , even with buying a lot older and more modest home we also had to dip into our super and arrived at your sweet spot.
Yes life is still OK and we have no complaints , however we will eventually down size agin to recover that Super Lump Sum drawdown. Additionally will then be able to loosen the Centrelink shackles to some degree and not be so much beholding to the constant political “ tweaking “ around retirement incomes .
If we could do it all over again ,would much prefer to have that extra K250 and leave the “ sweet spot “ to others.
Just a personal opinion as all circumstances are different.
Super is a Bottom of the Harbour legal Tax Haven. A healthy Super account has lots of advantages till pensionable age. Then the stats need to be revisited for ‘a more comfortable’ retirement. And don’t forget the gifting rules.
Thank you, Sean, but I would go further than restoring the previous taper rate (which of course is a no-brainer, as it should never have been altered the way it was!). I believe the aged pension should be free of any means test at all, but retirement income should be taxed. Other countries do it that way and it works. At very least, we should abolish the economically unsustainable assets test which actively discourages saving for retirement, financial planning, and sensible lifestyles. It encourages gross over-investment in the family home – and removing that incentive would be very helpful in resolving the current housing crisis, but we don’t have much brain-power in Parliament it seems!
It would remove incentives for overspending and enable people to better equip themselves to cover unexpected medical, dental and optical costs and costs for home help and aged care. Presently, we are punished for striving to position ourselves so that we can afford what we need in the winter of our lives, which increases the burden on government and also denies us the care that would make aging so much easier. Worse than denying us, it actually denies us the right to provide it for ourselves! How perverse is that?
I have friends who gave their kids $3 million before turning 60 so they could get a full-aged pension. They live in a $1.5 mil house much larger and more lavish than they need or want. Their kids pay most of their bills. They live in luxury. Compare them with the couple who carefully held on to their $600K in hard-won savings and their modest $400,000 home unit, and the latter are watching their pennies and denying themselves luxuries, and too afraid to help their children who are in crisis for fear the gifting rules will slash their income.
Couple X bought a luxury caravan and did the great Oz circuit, plus took a world cruise, then came back to collect a full age pension, retaining just a few hundred thousand earning interest as top-up income. Couple Y spent the first decade of retirement at home caring for aged and frail loved ones. No pension, because of their assets. By the time their loved ones passed and they felt free to invest in themselves, they had been compelled to draw too heavily on savings to fund living expenses and hadn’t enough left for that grand trip they had dreamed of. Lesson: DO NOT take responsibility for caring for loved ones. Ditch them and let the government take on the burden while you go and indulge yourself. What insane government policy! Are the people we elect to make these decisions complete fools?
Retirees are buying expensive homes to retain assets that are exempt from testing, so that if they run out of money they still have an asset they can sell or borrow against to cover unexpected costs or just fund a little top-up income to supplement their pension. And we have a housing crisis. Duh! But no doubt the government’s response would be to add the family home to the assets test if they thought they could get away with it – not to do the sensible thing and abolish the sinister assets test that is doing so much harm.