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Morrison in the Middle: Changes to Age Pension Eligibility

Nothing has highlighted the unintended consequences of tinkering with retirement income more than last month’s federal budget.

The fiscally and politically potent combination of age pensions and superannuation is always complex, however this budget has left many financial analysts scratching their heads.

The proposed changes to the Age Pension eligibility criteria, put forward by Minister for Social Services Scott Morrison, will have major ramifications for retirees who had carefully planned for their financial future.

While the tighter rules are designed to stop wealthy retirees living off the government, it’s likely they could have the perverse effect of encouraging pensioners to blow their savings just so they can continue to receive benefits. The formula just doesn’t add up.

A look at the numbers

Meet John and Jan, who are retired. They own their family home and have $375,000 in superannuation assets. Under the proposed new legislation, they are eligible for the full age pension. Like most retirees they will invest in “safe” investments and expect to make a modest return of around 3% on their super. This return, combined with their pension entitlements should deliver an annual income of nearly $45,000, whilst maintaining their capital. In theory they could choose to supplement this income by drawing down on their super.

Retired couple number 2, William and Sally who also own their family home have worked hard at saving for retirement and have a superannuation balance of just over $800,000. A figure they were told would deliver them the ‘comfortable retirement’ they desired (as defined by the Association of Superannuation Funds of Australia and published on the MoneySmart website). They have spent the last decade actively planning their ‘golden years’ and factored in an annual income of around $60,000.

Like many others William and Sally have been assuming the age pension would complement their income from the outset (roughly $15,000 out of the $60,000) and gradually increase over time to make up a much larger proportion in their latter years. The balance would consist of around $25,000 in super earnings (based on the same 3% earning rate as John and Jan) and an annual drawdown of $20,000 on their super balance.

But on budget night, the government turned William and Sally’s plans on their head. Under the proposed new rules, William and Sally are no longer eligible for any government pension at all. In the proposed new environment the “comfortable” retirement they were promised will now cost a further $15,000, increasing their super drawings to $35,000 per year.

Put in perspective John and Jan (receiving a full pension) could choose to live on a similar income by drawing only $15,000 from their super per year.

It’s estimated that William and Sally would be among 300,000 full or part pensioners set to receive less if the government changes are legislated. According to analysis by Rice Warner, half of all people leaving the workforce within the next decade will be affected. For these middle retirees, the obvious alternative is to spend more assets more quickly in order to qualify for the part or full pension … for a nation facing a ‘budget crisis’ this seems contradictory.

The direction of the overall policy indicates a greater expectation that Australians will plan and provide for more of their own retirement in the future. But unfortunately Mr Morrison’s formula will squeeze middle retirees the most.

There has already been a substantial amount of commentary around the inequality of these changes, a sentiment it would seem Bill Shorten and the Labor party share. On Tuesday Labor attempted to block the proposal only to have the move foiled by the Greens who announced their support, conditional on the Government considering changes to superannuation in its Tax White Paper.

Let’s hope that good sense prevails with an outcome that considers the reality of the numbers, the retrospective impact of the proposal and acknowledges that, for most retirees, income from super and from the pension is totally intertwined.

At it’s core the strategy of the government is not without merit but to introduce the changes retrospectively undermines the integrity of the plans laid out by current and soon to be retirees. If the changes were to be introduced for people retiring after 2025, plans could be amended accordingly.

We will keep you updated but expect this one will continue to be a “watch this space”…

NO WILL? IS IT REALLY A PROBLEM? YOU BE THE JUDGE.

th-4Ten years ago Mattt and Tom set up in business together selling high level technical advice to the   physics departments of universities. The business operates via a company in which Matt and Tom each hold equal numbers of shares and is very successful. Both Matt and Tom make significant amounts of money from the business. Matt uses most of his share to fund his hobby, research into the abstruse aspects of nuclear physics while Tom has more conventional investments.

Tom bought a house almost as soon as the business was established and his income was secure enough to fund the mortgage which he rapidly repaid. About six years ago Penny, a long-time girlfriend of Toms moved in with him and they now have two children, Hamish and Pipa. Tom has almost $200,000 in superannuation which he believes should go to Penny if anything happens to him.

Tom has been advised by both his financial advisor and his accountant that he should have a will and that he and Matt should document an agreement to make provision for what will happen to the business if one them wants to leave, becomes unable to work or dies. Tom recognises that this is a good idea but he has not got around to it. Tom is young, healthy, successful and happy, he knows Penny is legally recognised as his de facto spouse and thinks everything he owns will go to her anyway so it’s not that important to have a will. Tom is run over by a bus. Tom dies.

Penny does not own the house. Penny has no interest in the business. Penny had a joint bank account with Tom but his share of income from the company stops going into that account after his death.

Tom is no longer contributing to the business so no more wages are paid into the bank account. The private company has never paid dividends; it reinvests in research.

Penny goes to see a lawyer and finds out the following:

  • Tom never made a binding death benefit nomination over his superannuation account so Penny must apply to the fund to release the superannuation money to her.
  • Tom’s estate cannot be distributed to anyone until letters of administration are obtained.
  • Penny can apply for letters of administration but she will not be entitled to all of Tom’s estate.
  • The only significant assets Tom held were their home and shares in the business.
  • The house is now worth a little over $1 million and there is no mortgage.
  • The business is hard to value but Penny remembers that Tom and Matt, recently obtained a bank valuation to take out a loan which put its worth at about $1million – Matt disputes this. In his view the business is worthless without him.
  • Under the legislation Penny is entitled to $100,000 and half the remainder of Tom’s estate.
  • Hamish and Pipa are entitled to the other half of  Tom ’s estate divided equallybetween them, but as they are minor children the public trustee will hold their respective shares of the estate and invest it prudentially to build up wealth for the children (less the trustee’s not insignificant fees) when each of them turns 18.

The lawyer advises Penny that Tom’s estate is worth at least $1.5 million dollars of which she is entitled to $100,000 + (1/2 x $1.4 million) = $800,000.

However, as there is no will she is not executor of Tom’s estate and does not control it. The estate passes to the public trustee which will control the estate until Penny gets letters of administration which will allow her to wind up the estate.

As there are minors with a claim on the estate, Hamish and Pippa, Penny must find a ‘surety’ before letters of administration will be granted. That means she must find someone with sufficient assets to guarantee the full value of the estate before the Court will give her authority to deal with the money.

She may also have to go to court to persuade Matt to buy Tom’s shares in the business.

The trustee of the superannuation fund has agreed to pass the superannuation balance to Penny so she does have something to live on and to pay her not insignificant legal fees. However, the Public Trustee wants to sell the house to realise the children’s $700,000 share of the estate for which it is prudentially responsible.

It looks like Penny will have to sell the house and move somewhere smaller with the children. She will also have to take them out of the fee paying school they currently attend as she has no means of finding the fees and she will have to try to find a job as she has no source of income.

Penny’s friend Amy explained to Penny, unfortunately too late, what should have been done.

Tom should have had a will. The executor of a will can obtain probate and deal with assets far more quickly and cheaply than an administrator in intestacy and there would be no need to find a surety. If the family home had been left to Penny, or held in joint names she and the children would be able to continue to live there rather than having to sell it in a depressed market and move at the behest of the Public Trustee.

A binding death benefit nomination over Tom’s superannuation would ensure that Penny got the cash rather than leaving her at the mercy of an unknown trustee’s discretion.

Tom should have agreed with Matt on what was to happen to the business if either of them died. An option agreement in place could have given Tom’s executors a right to sell the shares to Matt for an agreed amount. This could be funded by life insurance to ensure Matt had the cash.

Ideally, all Tom’s estate would have been left to a testamentary trust Penny controlled. Pippa and Hamish could have received distributions of income from that trust at adult tax rates. This means Hamish and Pippa between them could each year receive up to $36,400 tax free from the investment of the money received for Tom’s share of the business.

FinSec and their legal associate Donaldson Walsh Lawyers could have assisted Tom with all these matters and so ensured that his unexpected death did not create major financial problems for his young family.

Source: Julie Van der Velde, Senior Associate – Donaldson Walsh Lawyers