Age Pension changes make retirees with more savings worse off in short-term

It is important to note however that although the couple with more in super will receive more total income over time, it will be substantially less than the $400,000 the couple saved in additional super. In other words, for the additional $400,000 in super savings, the couple only receive an additional $240,000 in additional total income.

Consider the outcome over the course of retirement for a couple retiring now with $400,000 versus a couple who has saved an additional $400,000, giving them a total of $800,000. We will assume both couples are home-owners.

Let’s assume a 2% real return on savings

We will assume that both couples invest their super in an account-based pension (also known as an allocated pension), which is by far the most common type of superannuation pension in Australia, and that each couple earn a net return after fees of 2% above inflation over the course of retirement.

We will also assume that there is wages growth of 1% p.a. above inflation over the course of their retirement (this is important because the Age Pension is linked to wage growth) and the pension they draw from their super is 5% of the starting balance in the first year, and kept at that amount in constant dollars thereafter (i.e. for a superannuation balance of $400,000, the drawdown in the first year for each retired couple is $20,000, and remains at $20,000 in constant dollars in every year thereafter until their superannuation balance is exhausted).

Since the annual withdrawal of $20,000 is 5% of the original, highest superannuation balance, and the remaining superannuation balance only earns 2% in real terms in subsequent years, $20,000 withdrawals in those subsequent years will become progressively more than 5% of the superannuation balance remaining in each of those years.

This scenario will mean that each retired couple will exceed the minimum withdrawal requirements for allocated pensions over the course of their retirement. For example, at age 75 when the minimum withdrawal requirement rises to 6%, each couple will already be drawing down more than 6%, and by age 85 when the minimum required drawdown is 9%, each couple will already be drawing down more than 9%.

I have stripped out inflation from the comparison, which means all of the figures in the results are expressed in “real” dollars – i.e. the figures are in current dollars. The Age Pension thresholds and payments as at 1 January 2017 are used. All amounts are shown in the tables at the end of this article.

Interestingly, if we were to introduce inflation into our constant dollar comparisons, the rate of inflation assumed would not change our conclusions: The original $20,000 would be indexed upwards each year by the inflation rate to maintain its real value, but the remaining superannuation balances would also grow each year by the 2% real return plus the assumed inflation rate, so savings would be exhausted at the same time as in the constant dollar analysis.

With these assumptions, the pension that both couples receive from their super will run out half way through the 26th year of retirement when they will be 90, if they start when they turn 65.

Outcome for couple with $400,000 in super: The couple with only $400,000 in super will be around $10,000 ($197 per week) better off in terms of total income in the first year and will continue to be better off for the first 6 years of their retirement. See Tables 1 and 2 below.

Outcome for couple with $800,000 in super: The couple with $800,000 in super are ahead on average over the first 15 years of retirement (when someone who starts at 65 will be 80). They are ahead on average by only around $3,000 p.a. ($58 per week). If you look at the situation over the course of 25 years, the couple with $800,000 in super are ahead on average by less than $10,000 p.a. ($186 per week). If we look at the total income over this 25-year period, the couple with a starting super balance of $800,000 will have enjoyed a little more than $240,000 in additional total income from their $400,000 in additional starting super. See Tables 1 and 2 below.

If we look at the total period until the allocated pensions for both sets of couples run out (which will occur after 25.5 years, after which both couples will receive only the full Age Pension), the couple with a starting super balance of $800,000 will have received a little more than $250,000 in additional total income from their $400,000 in additional starting super.

What if the real return is higher, at 3%?

The people with more in super are actually worse off if we change the assumption of earnings in retirement from a net return after fees of 2% above inflation to a net return after fees of 3% above inflation.

With the higher return, the couple with $400,000 in super will still be around $10,000 better off in the first year and will now be better off for the first 9 years of their retirement AND will on average be over $1,000 p.a. ($22 per week) better of over the first 15 years of retirement compared with the couple with more in super (note the couple with more in super were better off over the first 15 years in the case with a lower return). See Tables 3 and 4 below.

The couple with $800,000 in super will still be better over 25 years, but only by around $6,300 p.a. ($121 per week) rather than almost $10,000 p.a. on average ($186 per week).

What is problematic from a policy point of view is, if we look at the total income over this 25-year period, the couple with a starting super balance of $800,000 will have received around $158,000 in additional total income from their $400,000 in additional starting super, which is considerably less than the $240,000 in additional total income over 25 years with the lower return (2% above inflation), and considerably less than the savings devoted to generating the total income.

If we look at the total period until the allocated pensions of both couples run out (which will now occur after 30.3 years with a 3% real return, and then both couples will receive only the full Age Pension), the couple with a starting super balance of $800,000 will have received only $264,000 in additional total income from their $400,000 in additional starting super.

Is saving more a good deal in terms of cumulative retirement earnings?

Australians in the savings trap who get lower initial total income than if they had saved a smaller amount of superannuation and relied more on the Age Pension will, over the long run, get more total income than those who saved less.

However, the increase in total income over the course of their retirement will be less than the amount of additional super they have saved, even after allowing for earnings.

In fact, higher earnings make the situation worse for those who save more by delaying the run down of the savings and deferring or decreasing their eligibility to receive more in the way of Age Pension.

This result comes about because of the very high withdrawal rate for the Age Pension under the new Age Pension assets test taper rate (which equates to an effective tax rate of greater than 100%) that came into force from 1 January 2017.

In other words, across a large range of super balances, the sharper taper rate of the Age Pension assets test put in place from 1 Jan 2017 means that people will either receive an increase in terms of total income over their retirement that is proportionately much less of their increased savings than under the old Age Pension assets test or, if they try to achieve (and maintain over time) the same total income as is available from lower super savings, they will be forced to draw down their super more quickly than under the old Age Pension assets test.

In changing the taper rate for the Age Pension assets test, the government has taken us from a system where the old taper rate never put those who save more in a situation where they were less well off in terms of total income, though it narrowed the advantage that better-off Australians had over those who are less well off. In other words, Australians who had larger retirement balances were still better off in terms of total income in each year of their retirement, and the old rules gave them much more of their increased savings back in the way of increased total income.

The outcome under the pre-January 2017 Age Pension rules was that the couple with $800,000 in super always enjoyed more total income every year and over the period until their super ran out. would have enjoyed around $344,000 more in total income compared to the couple with $400,000 in super with a real return of 2% (with 3% it would be around $390,000).

What we now have with the 2017 Age Pension changes is a much more punitive system for people who save more: they spend quite a few of the earlier years of their retirement with a lower total income than those who have saved less. The couple with $800,000 in super over the period until their super runs out will only receive around $252,000 more in total income (from the extra $400,000 in savings) compared to the couple with $400,000 in super with a real return of 2% (with 3% it would be around $264,000).

As a final observation, it should also be noted that the years in which the couple with more in super receive a meaningful advantage in total income is weighted toward their later years of retirement, not their earlier years when they are more likely to have good enough health to be more active and require more income to fund their activities.

The comparison becomes even worse for savers with higher super balances if we allow for the time preference that we all exhibit for a dollar of consumption today rather than a dollar of consumption tomorrow.

Table 1: Total higher income (Real Return = 2.00% per annum)

Table 2: Which couple is better off in total income (Real Return = 2.00% per annum)?

First 6 years: Couple with less super better off
Year 7 onwards: Couple with more super better off

Table 3: Total higher income (Real Return = 3.00% per annum)

Table 4: Which couple is better off in total income (Real Return = 3.00% per annum)?

First 9 years: Couple with less super better off
Year 10 onwards: Couple with more super better off

About the author: Sean Corbett

Sean Corbett has worked in the superannuation industry for more than 20 years, principally working in the areas of product management and product development. He has a specialist knowledge of annuities, having worked at Challenger, Colonial Life, Connelly Temple and Oasis Asset Management. Sean holds a Bachelor of Commerce from Queensland University, and also holds an undergraduate degree with honours in economics and a masters degree from Cambridge University.