Pension plan adds up to better returns

What is often overlooked in thinking about how you are going to fund your retirement is the possible access you might have to at least a part-age pension.

A lot of people are out and about spruiking the need to have more than $1 million in investments to retire comfortably, whereas, in reality, a combination of some part-age pension and some strategic use of that age pension might provide a more than comfortable retirement with well under $1 million of assets.

In this article I look at how a part-age pension might be considered strategically within your investment situation, and next week I will look at how much you might expect to live on given different levels of your own assets mixed with the age pension or part-age pension.

Today various increases to age pension rates came into effect. For a single person, the basic rate of $772 a fortnight (base pension and supplement) has been increased to $808 a fortnight (including the clean energy supplement), and for a couple, the basic rate of $1,164 a fortnight (total for both) has been increased to $1,218 a fortnight.

Perhaps more interestingly is that the asset test has increased. Of the two tests that are used to limit access to the age pension (the income test and the assets test), it is the assets test that generally restricts how much age pension any person gets. The maximum level of the assets test – the level of total assets where you still receive some part-age pension if your assets are under this level – is now:

• $1.086 million for a home-owning couple (total for the two people)
• $1.22 million for a non-home-owning couple (total for the two people)
• $731,000 for a single home-owner
• $871,000 for a single non-home-owner

These figures exclude the principal place of residence, which remains exempt from the assets test. In September 2007 the federal government reduced the rate at which people with assets had their age pension reduced. Previously, for every $1,000 of extra assets they had, they lost $3 per fortnight of age pension benefits. That was reduced to losing $1.50 of age pension benefits for every $1,000 of additional assets.

The impact of this slower rate of losing access to the age pension because of extra assets, plus the increases to the age pension over time, mean that people can have a significant level of assets and still receive some age pension benefits.

In fact, I suspect a lot of people don’t realise the relatively high level of assets, set out above, that they can accumulate while still receiving some part-age pension.

This might be interesting to a variety of people at the moment. With the poor investment returns over the past 10 years, many people may have less assets at retirement that they had hoped – smaller superannuation balances, losses from geared investments and losses from poor market timing decisions as the volatility of the past five years unfolded. On top of these factors it is worth remembering that people retiring now have only had access to the 9% compulsory superannuation contributions for about 10 years, with contributions only increasing to this level from July 2002.

There seem to be plenty of reasons why people at retirement now may not have the level of assets to independently fund their retirement. Indeed, a Challenger Retirement Income Research report (April 2012) entitled ‘How Much Super do Australians Really Have’ suggested that this year the median superannuation balance at retirement for Australians will be around $140,000. Even if a couple has twice that level of assets, and some additional non-superannuation assets, they will still qualify for some part-age pension.

Using a Part-Age Pension Strategically

The question is then, how should the receipt of a part-age pension be considered amongst your overall portfolio?

Aspect one is that I would consider a part-age pension to be a reliable, ‘risk-free’ part of your portfolio. While spruikers of aggressive (and later failed) investment schemes have often talked about the possible future withdrawal of the age pension as a reason people should take part in these schemes, there seems to be little risk of the age pension being withdrawn in the foreseeable future.

Therefore, it can be relied on to provide a steady and reliable stream of income.

On this basis I would consider it a source of cash-like returns. This means that a person who is in receipt of some age pension can consider this income as coming from a cash-like investment – allowing them, if they are inclined, to have more ‘risky’ growth assets (generally property or shares) with the remainder of their investments.

I would try to organise this using an ‘income planning’ approach. I would calculate all the cash needed over the next five years, including regular living costs and any additional expenses like travel.

Let’s say a home-owning couple wants to live on $30,000 a year (about $600 a week) and spend $10,000 on travel – a total of $160,000 over five years. I would then look at how much of that is provided by the part-age pension. Let’s say this couple is receiving around half the age pension, about $16,000 a year. Over five years they would receive $80,000 in age pension.

I would suggest that they have another $80,000 of their investments in cash assets – giving them confidence that they will have all their living expenses covered. Given that they are likely to have a portfolio of around $550,000 to be receiving this level of age pension benefits, it leaves the more aggressive investor with up to $470,000 ($550,000 minus $80,000 cash) to invest in growth assets without having to worry about medium-term cash needs.

And, over that period, their cash will be topped up be the income (dividends, rent or distributions) from their growth assets.

Dampening Volatility in a Portfolio

Another benefit of having access to a part-age pension is that it can ‘dampen’ the volatility in an investment portfolio. When the value of assets fall, then the age pension received will actually increase.

Consider the very simple case study above. Let’s assume that this couple is aggressive and has all of their $470,000 invested in Australian shares, and the sharemarket falls by 50%. This leaves them with only $230,000 in Australian shares.

Just as the age pension decreases by $1.50 per fortnight for every extra $1,000 in assets, it will increase by $1.50 per fortnight for every $1,000 reduction in assets. The impact for this couple is a significant drop in portfolio value but an increase in their age pension received of $335 per fortnight. This will likely make up for any drop in dividends and, along with their cash assets, should allow them plenty of time to recover.

Conclusion: The Balancing Act

I think it is unlikely that many people will be suited to being quite as aggressive in terms of having more than 80% of their retirement investments in growth assets as I have illustrated in the simple case study.

However I hope that it shows that, if you are in a situation where you are receiving some age pension, it can play a significant role in protecting you from market downturns and meeting your short and medium-term cash needs.

A part-age pension, as part of your situation, can add a real defensive quality to your financial circumstances and, as I will look at next week, it can help provide a comfortable tax-free retirement income stream when mixed with some investments of your own.

Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.