There has been great pressure on both of the major political parties to stop giving so-called rich retirees partial pension income. The conventional view has become that retired millionaires should not be feeding off the public teat.
At first glance this seems entirely reasonable. A million dollars, or anything close to it, sounds like an awful lot of money. But if we factor in current interest rates on the lowest risk option, term deposits, we get a very different picture. In terms of income, many of those ‘rich retirees’ would actually be better off on the pension.
Both the lower limit and upper limit on the assets test will change from 2017. At the lower end, the Government will increase the assets test limit to qualify for a full pension, from $286,500 to $375,000 for couples, and from $202,000 to $250,000 for single people. At the other end, the upper limit for receiving a part-pension and the associated benefits will fall: from $1,151,500 to $823,000 for couples and from $775,500 to $547,000 for singles.
The income from the aged pension is $860 a fortnight, or $22,360 a year for singles, and $1296 a fortnight, or $33,696 a year, for couples. Let us assume that single or couple retirees choose term deposits because they need income and they have a low tolerance for risk, so are unwilling to choose other riskier options, such as investing in shares. How much capital will they need to get the same result as the aged pension from a term deposit as the aged pension?
At current term deposit rates of about 2.5 per cent, the single retiree would need assets of $892,000 – $345,000 above the proposed upper limit cut off rate – to receive the same income as the full aged pension. Couples will need $1.3 million – $477,000 above the cut off rate – to get an equivalent income to the pension. So the government’s plans to cut off pensions at a lower asset rate will notionally put many retirees who have saved for their retirement in a worse position than if they had saved much less and gone on the pension instead.
The good news is that couples that have no, or low, savings and so rely on the aged pension are actually ‘worth' well over a million dollars, at current interest rates. A single retiree is ‘worth' almost a million dollars. It is further demonstration of the manner in which Australia’s social welfare system is a great equaliser. But for those who have saved, the outcome may not be as good.
There are a few assumptions here. This analysis only looks at the income, whereas retirees can run down the principle over time. It is also unlikely that retirees with more than $800,000 will rely only on term deposits. Most will attempt to persify their investments between bonds, shares and cash in order to get a significantly better return. Other low risk options, such as annuities, could also provide a significantly higher return than term deposit rates, although just what that final return will be can be difficult to assess because the annual income is based on a formula that takes into account investment costs, investment risk, profit for the operator and administration and marketing costs.
The implication for those who will now be cut out of the part pension payments is that it makes sense to take greater investment risks, or perhaps even go on a spending spree to pest assets. It certainly does not make sense to take out a term deposit at current interest rates.
The global financial markets have, since the global financial crisis of 2007-08, been extremely distorted. Interest rates have been negligible across most of the developed economies, and there seems to be little sign that they are about to rise significantly. Australia, which was exempt for a long time, has now been drawn into that problem. It has led to a world-wide pursuit of riskier investments in the hope of getting better returns. It is likely that Australia’s ‘wealthy’ retirees will be joining that chase. At least if they lose out they will have the aged pension as a fall back.
David James is a business journalist with a PhD in English literature. He edits Personal Super Investor.