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Spending in retirement and the taper rate

There are a few key questions that people need to think about when planning for their retirement, such as:

  • How much do I need (and can afford) to save for my retirement?
  • How do I invest my superannuation to improve my retirement outcome?
  • How do I safely draw down and spend my savings during retirement?

As compulsory Superannuation Guarantee (SG) contributions only commenced in Australia in 1992, starting at 3% of earnings and gradually increasing to 9% by 2002, it is fair to say that our superannuation system is still relatively immature. In addition, the SG only applies to employees who earn more than $450 in a calendar month and doesn’t apply at all to the self-employed and contractors in the so-called ‘gig economy’.

Large super balances are relatively new

Thus, it is only recently that a significant number of Australians began retiring with material amounts of retirement savings, with around 35% of superannuation balances at retirement reaching $250,000 or more.

Over the next 40 years, this proportion is expected to double, with around 70% of superannuation balances at retirement in 2060 expected to reach $250,000 or more (in today’s dollars). Indeed, by then, around 40% of superannuation balances at retirement are expected to reach $500,000 or more (in today’s dollars).

Retiree confidence to draw down more

There have been numerous studies, including one by CSIRO-Monash Superannuation Research Cluster, which indicate that most retirees in their 60s and 70s draw down on their account based pension (ABP) at modest rates, close to the minimum amount each year (which is 5% of their account balance for those aged 65 to 74). This behaviour will result in them living an unnecessarily modest retirement, many behaving as if they are in poverty.

There have been many reasons proposed for why retirees behave this way, among them a fear of running out of money and uncertainty about how long they will live. Some might also want to leave the home as a bequest, so they don’t consider using the equity in their residence. Hence, they try to manage their own longevity risk by spending cautiously.

Since the early 1970s, the life expectancy of the average 65-year-old has increased from about 12-13 years to 20 years for men and 22 years for women. But longevity is not uniform, it varies considerably from person to person, so some form of longevity protection will be helpful for many Australians.

A retiree’s draw down and spending strategy is also driven by how much savings they have and how the assets test affects their eligibility for the age pension.

When is age pension eligibility lost?

The relevant assets test thresholds are set out in Table 1, with a full age pension applying below the lower thresholds and gradually reducing to zero when the value of assessable assets exceeds the upper thresholds (noting that some assets are excluded from the assets test, such as a person’s main residence).

If a retiree has less than $300,000, then they will be entitled to a full age pension for most (if not all) of their retirement and it will be their major source of income. In this situation, their superannuation savings will supplement their income and the age pension provides a good income base as well as adequate longevity protection in most cases.

On the other hand, if a retiree has more than $800,000 then they are also likely to be homeowners and, after taking into account other non-superannuation assets, are less likely to be eligible for much, if any, age pension during their retirement. In this situation, their superannuation is predominantly a substitute for the age pension and, in addition, they often have the capacity to not have to draw down as much of the capital component of their savings.

The age pension is likely to provide enough certain lifetime income for low balance members, and high balance members won’t necessarily need to draw on as much of their capital anyway. But the high proportion of Australians in the middle (with superannuation balances between say $300,000 and $800,000) could benefit greatly from more certainty for more of their retirement income.

This ‘middle’ group will be eligible for a part-age pension for a substantial portion of their retirement and, as a result, the means test rules will be an important consideration for them.

For this middle group, it is therefore worth noting that legislation was passed in February 2019 to amend the means test rules that apply to longevity protection products with effect from 1 July 2019. Under the new rules, only 60% of the purchase amount of a lifetime income stream will be an assessable asset and only 60% of the payments will be income for the means tests.

These regulatory changes should, in time, promote the development of new longevity protection products such as deferred lifetime annuities (DLAs) or deferred group self-annuitisation (GSA) products which should help retirees plan their retirement spending with more confidence.

What is the ‘taper rate’ and when did it change?

The taper rate is another important part of the assets test used to determine eligibility for the age pension. Since 1 January 2017, a retiree’s annual pension is reduced by $78 for each $1,000 of assets above the relevant lower thresholds (as set out in Table 1). Before 2017, the taper rate was half that amount, at $39.

At the time of the change to the taper rate in 2017, the lower thresholds were increased by more than 30% which, according to the government meant that more than 50,000 part-pensioners became eligible for a full pension for the first time. As the SG system matures, more people are expected to retire with higher superannuation balances and as a result of this change are expected to lose more of the age pension.

How does the taper rate impact retirees?

To understand its impact, let’s look at some cameos for a worker on average annual earnings of $90,000 and compare the results for a superannuation contribution rate of 9.5% versus 12% (i.e. an additional 2.5%) paid over 40 years to age 67. Based on a marginal tax rate of 32.5%, if fully offset or sacrificed, the person’s net take home pay would reduce by about $61,000 over the 40 years.

Following retirement at age 67, if the retiree is a single non-homeowner and draws down the minimum amount over 23 years to age 90, then the increased income produced by the additional savings is partially offset by a reduction in the age pension as set out in Table 2.

On the other hand, if the retiree gradually draws down all their capital over the 23 years to age 90, they not only gain the benefit of spending more of their savings, but they also become eligible for higher age pension payments sooner. Note that the ‘minimum drawdown’ scenario ignores any residual payments to beneficiaries and focuses on spending in retirement.

As Table 2 shows, if the retiree draws down and spends the minimum amount each year, the annual taper rate would need to be close to $39 for the retiree to receive total additional retirement payments higher than the accumulated reduction in the person’s net take home pay of $61,000.

Based on the current taper rate of $78, the retiree is caught in a ‘trap’ whereby their total additional retirement payments over the 23 years to age 90 (i.e. $21,000) are $40,000 lower than the accumulated reduction in the person’s net take home pay to fund their higher retirement savings.

The retiree would be in fact be better off under a $78 annual taper rate if they also gradually draw down and spend all their capital by age 90. In this scenario, the retiree’s overall net benefit would further improve with the lower taper rates.

A higher taper rate does encourage retirees to spend their savings as quickly as possible until they become eligible for the full age pension, but there is little evidence that this occurs in practice.

The confidence to spend

One of the problems facing retirees is the complexity around the means test. We need to find a way to deliver appropriate advice cost-effectively to help the growing number of people entering retirement with sufficient superannuation savings to encounter these problems. In particular, the ‘middle’ group identified earlier, who will be eligible for a part-age pension for a substantial portion of their retirement, need this guidance the most.

If one of the objectives of the superannuation system is to 'facilitate consumption smoothing over the course of an individual’s life', then this ‘middle’ group would benefit from:

  • encouragement to acquire longevity protection to give them more confidence to spend their savings during retirement
  • a fairer taper rate that does not unduly encourage them to spend their retirement savings too quickly, and
  • low cost access to information, guidance and advice to help them make better decisions about their retirement.

Given the interconnectedness of the system, it is important that all the relevant levers are considered in conjunction with each other, including how it impacts on the efficiency and effectiveness of any other changes such as increasing the SG to 12%.

 

Andrew Boal is the CEO of Rice Warner. He specialises in providing actuarial and strategic consulting advice to leading companies and superannuation funds. This article is general information and readers should seek their own professional advice. It is an extract from the Actuaries Institute Dialogue Paper called 'Spending in Retirement'. A full copy of this paper can be found here.

 

11 Comments
Dudley.
June 14, 2020

"most retirees in their 60s and 70s draw down on their account based pension ... close to the minimum amount each year ... many behaving as if they are in poverty.":

And save some or all in personal accounts.

CSIRO:
'This represents the cost of self-insuring for longevity risk'
'Framing is also likely to be important. ... switching from thinking about saving to thinking about spending may not be easy'

Our household response to decreasing real yields [ = (((1 – Tax_Rate) * Interest_Rate) – Inflation_Rate) ]
has been:
* to spend less (50% reduction last 2 years),
* to save more,
* to increase capital,
* to earn enough,
* to exceed expenditure (thus avoiding spending capital).

Could spend 5 times as much if drawing down capital from 70 to 110. "Spending comes with too many hassles relative to the benefits."

Ian McRae
June 12, 2020

Can anyone define how much affordable advice is?
What would the cost be for an initial plan?
What would the ongoing cost be?

john
June 11, 2020

Just wondering. How does centrelink determine whether a retiree has ??
1. given away as gifts in excess of $30,000 to such as children etc ??
OR
2. Upsized or home renovations, travel etc ??

Brian Richards
June 11, 2020

The biggest issue most retirees are concerned about is the threat of governments changing the rules retrospectively as occurred in 2017 with the change in the taper rate, this meant that circa 300k retirees lost a part pension.
Who knows how governments will target retirees in the future that reduce their retirement income further?. I suspect a tax on super pension earnings will be at the top of their hit list closely followed by taxing lump sum withdrawals. For this reason financial engineering along the lines Jeremy outlines cannot be gauranteed to be retained whilst retirees will have locked up money in an annuity
For this reason retirees are concerned enough to restrict their spending patterns to ensure they do not get caught out be future changes that would leave them with even less control of the assets. However governments should take account of the franking proposal that provided Morrison with the "miracle" he needed to retain government!

Kristin
June 13, 2020

Here here, couldn’t agree more. The uncertainty of the state tampering with the rules in exactly the way you describe is the biggest disincentive to indulge in any of this theorising. My retirement outcomes and quality of life in the hands of the government, no thanks.

Jack
June 11, 2020

If a pensioner couple in this middle group can reduce their assets by $100,000 they would INCREASE their pension by $7,800pa, because of this harsh taper rate. This is considerably more than that $100,000 can earn if it was invested in any other way.

As the family home is a non-assessable asset, reducing assets to become eligible to qualify or increase their age pension is not difficult through upsizing or home renovations. Alternatively it can be spent on personal items such as travel. There is considerable evidence of this behaviour.

Ironically it cannot be given away as gifts in excess of $30,000 are still considered assessable assets for 5 years after the gift is made.

The taper rate creates a perverse incentive to reduce capital in retirement and this has implications for how much the pensioner couple can contribute to their own age care. Go figure.

Jeremy Cooper
June 11, 2020

Here is a case study on how a part pensioner can beat the so-called 'taper trap' or 'retirement trap/tax':

Sue is a 66-year-old single female homeowner with $540,000 in super.

Many believe that age pension rules penalise her for having built up that amount of super. They say that, if Sue had $100,000 less, she would be better off. She would get an additional $7800 in age pension each year – income she would find hard to earn on that $100,000.

However, consider what happens if Sue invests $100,000 of her super in a lifetime income stream, such as an annuity. In the week starting June 1, the annuity pays her $5316 a year for the rest of her life, plus she has still got $440,000 of her super.

Under the age pension assets test, just 60 per cent of her annuity is counted. This means Sue gets $3120 more age pension a year and her "taper hurdle" drops to $4680. With the $5316 a year from her annuity, and additional age pension payments, her cash flow now totals $8436 for the year.

My views on this issue are summarised in an SMH article here:

https://www.smh.com.au/money/super-and-retirement/debunking-the-retirement-trap-myth-20200605-p54zux.html

The idea that the government solves this by handing out more age pension so that people can keep their super is increasingly surreal in the current fiscal circumstances.

john
June 11, 2020

Hi Jeremy.
In the link you gave you mentioned :
Her cash flow now totals $8436 for the year.
Would it be right to say instead as follows ??
Her cash flow now increases by $8436 for the year. ??

Bearing in mind that would be lessened as there would have been some sort of return anyway depending on where the $100K was invested

Jeremy Cooper
June 11, 2020

Hi John, word count limits how much we can say. In the case study, we didn’t go into what Sue would be earning on her $100,000 prior to investing in the annuity. Implicitly, we were going along with the taper trap premise that she couldn’t reliably achieve a 7.8% pa return. What we were illustrating was a very safe way of consuming some capital, but at the same time achieving reliable lifetime cash flows above the taper rate. You could then, for comparison purpose, assess that outcome against an investment in a TD; an ABP or an equity income portfolio. Sue could, of course, do all of those things with the $440,000 balance of her portfolio.

I hope that helps.

Sue
June 17, 2020

Am l correct in thinking that with the said annuity, is only as good as you staying alive! If you were to commit say $150 000, to a annuity, that payment stops on your death, and maybe a reduced amount becomes payable to your beneficiaries. Still trying to understand the full implications. Thanks

Jim Hennington
June 12, 2020

I agree Jeremy.

The government already solved the 'taper rate trap' in 2019 when they introduced new means tests for super funds that convert your balance into full lifetime income (i.e. designed to be paid for exactly how long you live - even if that's age 110).

Traditional annuities achieve this. As will unit-linked annuities - for retirees who are happy to keep some money in growth assets and accept more risk/return.


 

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