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Although building your super account balance to ensure you have a healthy nest egg at retirement is a smart idea, there may be times when saving extra may not be your best course of action.
Oddly enough, new research has shown the current Age Pension rules and super system can interact to create a zone where in fact you are better off with less money saved in your super account at retirement.
So, are you at risk of falling into what is being called Australia’s new ‘retirement trap’?
What is the retirement trap?
The so-called retirement savings trap is a black hole in the retirement system where, for some retirees, saving and investing more means they actually end up with a lower level of income during their retirement.
Common sense would say accumulating more savings during your working life should result in a higher income during retirement. For some people, however, accumulating more means the reverse happens. In fact, they are actually penalised for saving more.
This strange quirk in the retirement system is due to the rules governing how much your Age Pension entitlement reduces as your retirement assets and income increase, as shown in this graph produced by National Seniors Australia.
Retirement trap in action
Source: National Seniors Australia, Fact Sheet: Age Pension asset test taper rate
How will the retirement trap affect your income when you finish work?
For most Aussies, their income in retirement comes from a mix of superannuation, Age Pension payments and income from any investment assets.
Retirees affected by the retirement trap rely on a combination of Age Pension payments and income from their super savings. As your assets and super savings increase, the government’s asset taper rate (see Explainer box below) reduces the amount of Age Pension you are entitled to receive.
According to new research by ETF-provider BetaShares, retirees caught in the retirement trap have an income range between $174 and $2,026 per fortnight. For every additional dollar they earn in income, their Age Pension entitlement reduces by 50 cents.
This effectively halves the value of your additional earnings if you fall into this income range.
If you are an individual homeowner with assessable assets above $263,250, your Age Pension entitlement is reduced by $3 a fortnight or $78 per year for every additional $1,000 you have in assets.
“For a retiree caught in the retirement trap, additional assets are better off spent, or, if they are invested, must generate returns that are well in excess of 7.8% per year to exceed the pension entitlements that are lost. Unfortunately, such investments generally entail taking risk above levels which are commonly recommended for retirees,” explains Dr Roger Cohen, BetaShares’ senior investment specialist who co-authored the study.
“The system implicitly encourages these retirees to spend additional savings or redirect them towards exempt assets like their homes, instead of choosing to invest them to generate income.”
Higher investment returns are no solution
Once you fall into the retirement trap, most retirees are unable to invest their way out of a lower level of retirement income.
The BetaShares study found retirees whose super balance falls into this zone must generate an unacceptably high rate of investment returns to compensate for the pension entitlements they lose under the government’s current taper rate.
To offset the reduction in their Age Pension entitlement, retirees must generate an annual return above 7.8% for each $1,000 they have invested.
Cohen says the retirees most affected by this anomaly in the retirement system are those with a super balance between $350,000 and $600,000.
His analysis measured retirement incomes using a ‘pension multiplier’ (a number greater than or equal to one), representing the current or future income stream a retiree can expect relative to the Age Pension. For example, a pension multiple of 1.5 means retirees can expect an income one and a half times greater than if they only lived on the Age Pension.
The study also compared the impact of using different investment strategies. It found even if retirees use a highly aggressive investment strategy with a high allocation to growth assets, it would not help them escape the retirement trap.
BetaShares modelling using different investment strategies and the retirement trap (light yellow region)
The analysis tested five different investment strategies ranging from 30% to 100% allocation to growth assets.
Source: Cohen, Chen and Zhu, The Retirement Trap, November 2019
Measuring the retirement trap: Danger zone expands
If worrying about the risk of falling into the retirement trap isn’t bad enough, some superannuation experts believe the size of the problem is even larger than previously thought.
A similar analysis of the issue by Industry Super Australia (ISA) found that for retiree couples with a 5% drawdown, their disposable income in 2019/20 went backwards if they held between $405,000 to $877,500 in assets.
ISA modelling showed the reduction in disposable income was from $55,854 to $43,875 over this range. So, a couple who saved more than $875,000 for retirement had $12,000 a year less to spend than if they retired with $400,000.
According to ISA, in the next decade more than 1 million Aussies will be caught in an ‘unfair retiree tax’ that will mean they end up with less spending money after saving more.
“The perverse pension means test really means that those who saved more have less to spend. It provides a disincentive to save, it flies in the face of reason and is just plain unfair,” argues ISA chief executive Bernie Dean.
Explainer – Age Pension and the taper rate
The Age Pension is means tested and uses an income and asset test to determine the level of pension an individual or couple is entitled to receive.
Broadly, it works as follows:
- Below a set income and asset threshold, you receive a full Age Pension.
- For each $1.00 per fortnight of income above this threshold, you lose $0.50 in payments per fortnight.
- For each $1,000 in eligible assets above this threshold, you lose $3.00 per fortnight.
This means as your retirement assets increase, you begin to lose part of the full fortnightly Age Pension payment. The rate at which you begin to lose part of your payment is called the asset taper rate.
The taper rate used for the Age Pension assets test was halved from 20 September 2007 as part of the Howard Government’s Simplified Superannuation reforms. Under this change, Age Pensions were reduced by $1.50 per fortnight for each $1,000 in assets above the free area.
As part of the 2017 reforms to super, the taper rate was doubled, returning it to the previous rate of $3.00 for every $1,000 of assets.
For more about the Age Pension asset taper rate changes, read SuperGuide articles:
For more information about the July 2017 super changes, and the January 2017 Age Pension changes, see the following SuperGuide articles:
- Age Pension assets test rules (March 2020 to July 2020)
- The rules of superannuation: Your guide for 2019/20
- Definitive guide to the $1.6 million transfer balance cap
- 2019/20 guide to non-concessional contributions (after-tax super contributions)
- 2019/20 guide to concessional contributions (before-tax super contributions)