More complexity for means-testing of the Age Pension
- On 25/01/2018
When the Financial System Inquiry published its final report in November 2014, it introduced the concept of Comprehensive Income Products in Retirement (CIPRs). These retirement income streams would have the objective of allowing retirees to pool mortality risks while increasing the amount of their pension payments, and therefore their living standards.
Despite a lengthy consultation process with Treasury, the superannuation industry has been slow to introduce longevity products. Those which have been issued (lifetime annuities and Group self-annuitisation products) have had low take-up showing that retirees are not convinced that they will meet the stated objective.
One of the difficulties is that the purchase of a longevity product does not increase value for a retiree. Rice Warner’s modelling shows that the present value of increased pension payments is more than offset by the reduction in the value of any benefit left behind on death (bequests). In addition, the long-term investment returns on longevity products are unattractive when compared with the investment pools of MySuper products which benefit from the equity risk premium.
Clearly, retirees (and their financial advisers) appear not to value the greater certainty of returns nor have they been convinced to live less frugally and draw down higher pensions.
As longevity products cannot be sold on merit, some industry participants have been lobbying to have preferential treatment of these products in the means-tests of the Age Pension. In last year’s Budget, the government stated that it would address ‘superannuation regulations that restrict the development of new retirement income products and act as barriers to innovation’. New regulations that came into force from July 2017 include a change in the tax treatment of deferred annuities and GSAs, which are now tax-free during the period of deferment after age 60.
Another problem raised by the industry has been the absence of a clear direction on how longevity products will be treated for the means-tests of the Age Pension. After the tightening of the means-test a year ago, only 44% of retirees above age 65 receive a full Age Pension. A million retirees (25% of the population who have attained age 65) are subject to the means-tests and receive a part pension while the remaining 31% (including some who are still working) receive no pension. The part-pensioners will grow as superannuation benefits rise.
Graph 1 illustrates that in 2017 the proportion of a given age cohort who are self-funded falls as age increases. The proportion of each age cohort receiving a part pension remains relatively stable across age cohorts.
Graph 1. Proportion of population over age 65 by Age Pension status (2017)
The 2010 Intergenerational Report estimated that only 20% of the population would be self-funded by 2050, but it appears the growth in superannuation balances since then together with the tighter means-testing will lead to this figure being easily exceeded.
Industry submissions were gathered a year ago and the Department of Social Services (DSS) has now released a Position Paper setting out its proposed rules for means-testing of longevity products:
- For the income test, 70% of all pension payments from a longevity product will count as income.
- For the assets test, 70% of the nominal purchase price will be counted as an asset dropping to 35% once the retiree has passed their life expectancy at the time of purchase.
To qualify as a longevity product, there will be no return of capital during the period beyond life expectancy.
The rules are clear but they could be simplified further by replacing life expectancy with a flat period of (say) 20 years. If the rules remain the same, DSS will need to know the life expectancy at purchase for every retiree – and they could buy several products at different times!
These rules will make longevity products more attractive for those people subject to means-testing. Once the legislation is passed, we can expect a surge of activity in designing retirement products.