Low level investment returns bite
Funding a comfortable retirement has always been a challenge for many Australians, but falling and volatile investment returns and increasing longevity are now making it even more difficult.
Low investment returns require larger annual savings to build up retirement assets and more capital to fund the desired living standard. Increased longevity can also present problems unless retirees can extend their working life and not access their capital at relatively young ages.
The age pension asset test changes to apply from January 1, 2017 will complicate retirement planning decisions further by reducing the benefits of owning investment assets in excess of $275,000 (single) and $402,000 (couple combined) plus the family home.
Declining investment returns mean that the benefits of receiving a part age pension exceed the after-tax returns of owning investments subject to the assets test. This won't change while official interest rates and conservative investment returns continue at historically low levels.
Decisions in retirement to run down capital can't be reversed at a later date by new earnings. While people in the workforce may be able to delay retirement to cushion the impact of low returns, those who are already retired have no or only limited options to do so. This explains, especially when investment returns are low, the attraction of a certain and steady income from a full or part age pension.
This income is paid fortnightly and indexed half yearly by the growth in inflation or average earnings - whichever is the higher.
Consider the relative situations for a home-owning couple with $402,000 of assessed assets eligible for a part age annual pension of $32,796 with that of a couple with assets of $1.3 million not eligible for any age pension under the new rules.
Assuming up to $50,000 of assessed assets are personal assets such as cars and household effects not generating any income, $352,000 and $1.25 million are available to generate income. With an annual return of 5 per cent, investment income would be $17,600 and $62,500 respectively.
Adding the age pension to the investment income increases annual income to $50,396 and $62,500 in these two cases. In essence, accumulating an additional $900,000 in assets generates an additional annual income of around $12,000.
However, gaining access to the age pension is much less relevant if investment returns are higher.
A 10 per cent annual return would, for example, generate pre-tax annual income of $125,000 from assets of $1.25 million compared with only about $67,000 from $352,000 of assets.
Taking into account the annual fluctuations in investment returns and the automatic indexation of age pension income, introducing the new tougher assets test when returns are low will inevitably lead many Australians to question the benefits of totally self-funding their retirement.