Australian retirees will need more than half a million dollars

24 January 2020

Australian retirees will need to accumulate over a half a million dollars to escape the ‘retirement trap’, according to the new analysis by BetaShares.

Ironically, the study showed that Australians at retirement age would need savings between $350,000 and $600,000, but increasing their savings may result in their income decreasing.

The anomaly, which is called the “retirement trap”, resulted from the progressive reduction of Age Pension entitlements as assets and income in retirement increase above certain thresholds.

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These reductions in income could occur because such savings increases were unlikely to generate enough additional income to offset the pension entitlements that were lost and the analysis noted that Australian retirees could only escape this ‘retirement trap’ if they could accumulate well over half a million dollars as above this point increased savings would lead to increased income.

“Common wisdom tells us that accumulating more savings through our working lives should result in higher income in our retirement years. However, our analysis shows that, for certain people, under the current system, accumulating more money can actually produce the reverse,” Roger Cohen, senior investment specialist at leading ETF provider BetaShares and the co-author of the analysis, said.

He explained that the current retirement system in Australia saw retirees drawing income from a combination of superannuation, the Age Pension and external assets, and these entitlement levels and associated reduction in the pension were the primary drivers behind the ‘trap’.

More specifically, for an individual, there was an income range between $174 and $2,026 per fortnight, where for every additional dollar earned, the pension was reduced by 50 cents and this effectively reduced the value of additional earnings for retirees in this range, according to the study.

On the assets side, for individual homeowners whose assessable assets are above $263,250, the pension is reduced by three dollars a fortnight (or $78 per year) for every additional $1,000 in assets. To offset this reduction, each $1,000, if invested, would need to generate an annual return above 7.8%.

“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 annum to exceed the pension entitlements that are lost,” Cohen said.

”Unfortunately, such investments generally entail taking risk above levels which are commonly recommended for retirees.

“The transition from full entitlements to the age pension to no entitlements needs to be smoother. It is certainly an undesirable situation that for some people, more is not necessarily more.”

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Any analysis of retirement lump sum requirements that assumes an age pension "entitlement" according to current rules, is flawed.

The current age pension system is unsustainable. If it stays the same there will be too many recipients receiving too much money, with not enough working taxpayers to pay for it. Compulsory superannuation will marginally ease this problem but won't solve it. The only solution is a reduction in age pension "entitlements" over time. Advisers should be helping clients achieve retirement lump sums that aren't dependent on an age pension top up amount that may no longer apply in the future.

I totally support the findings of the BetaShares analysis. The assets test taper rate is too high and this causes undesirable and inappropriate incentives and disincentives. A paper "The Age Pension Means Tests: Contorting Australian Retirement" by A/Prof Anthony Asher and myself to the 2018 Actuaries Convention showed that depending on assumptions about earnings rates and drawdown rates, sometimes having an additional $200,000 at age pension eligibility date is MORE THAN OFFSET by the foregone future age pension. Where is the logic in that? What is the value of a system where you are financially better off having LESS money in retirement than having MORE money? This result doesn't apply in all cases; in other cases, retirees don't lose ALL the value of their additional savings, only MOST of the value of those savings. The situation is worst for the top two thirds of the asset testing range (roughly $375K to $575K for single homeowners, roughly $550K to $860K for couple homeowners, add $210K for non-homeowners).
Yes there are things you can try to do about it (eg home renovations, UPSIZE (!!) your home, more to a more upmarket location, give some away (but there are tight limits unless you do it 5 years in advance), prepay your funeral, go on an overseas trip, buy a life annuity) but these are distortions caused by a flawed system.
When the government reduced the asset limit for part age pension and increased the asset limit for full pension (and in both cases I understand and sympathise with what they were trying to do: more support for less well off pensioners, less for those with more assets) the unfortunate side effect was a doubling of the taper rate, from 3.9% to 7.8%. The government defended this on the grounds that it was merely a return to the former taper rate. But interest rates were much higher before 2007 than they are now, so the impact of the taper is more severe now.
Anon is right, at some point age pension entitlements must be amended but it's probably not the maximum amount of the age pension that needs to be addressed, it's the means testing structure. (But Anon you're wrong about the eventual impact of the SG: in the long run that will have a BIG impact on the amount of age pension payable. It's just that the system takes a very long time to mature).

But while I fully agree that there is a "retirement trap" caused by the too-high asset test taper rate, I'm not sure that means that you need more than half a million dollars to retire. Scott Pape's Barefoot Investor book rightly points out that there is a "sweet spot" in the current Australian age pension means testing environment where you can have assets slightly above the lower asset testing limit, and still have a comfortable retirement, assuming that you can earn just a little bit of income in retirement (but not so much that the income test starts to "bite"). His example for a home owning couple assumes only $250K in assets. It's true though that it won't suit all pensioners to work one day a week, especially as they get older.

John, I haven't read your paper, but based on your comments I do wonder whether it addressed the biggest contortion and inequity of all in the age pension means test…. the uncapped exemption for principal residence. Any system that gives taxpayer funded cash handouts to people who live in million dollar homes cannot be regarded as fair or sustainable. Particularly when so many of those young taxpayers are struggling to afford a simple home themselves.

And please don't try to defend this obscene inequity with tired old lines about "pensioners being forced out of their homes". Many of those pensioners would gladly move, but are pressured to stay put by greedy relatives keen to maximise their inheritance. For those who genuinely want to stay, the Pension Loans Scheme can provide them with even more income than the age pension, by facilitating a small equity drawdown from their property value.

Sooner or later the young taxpayers of Australia will figure out they are being utterly rogered by the age pension system.

Hi Anon,
Thanks for your further comment ... and far from trying to defend the inequity of the uncapped principal residence exemption.... I fully agree with you! The principal residence exemption was also covered in our paper, and we were hostile to the uncapped exemption. (Actually it was my co-author, Anthony Asher, who has a very strong sense of social justice, who felt especially strongly about that issue, but when I thought about it, I certainly agreed with him). There have been many independent reviews of the retirement incomes system, ALL of which (as I understand it) have opposed the uncapped exemption. I totally share your view, but I'm concerned that there is entrenched (though irrational) public support for this measure. At least from home owning retirees! It would be difficult for any government to change, and this government seems to have ruled it out already. The change will be difficult, and there will need to be transitional arrangements, but that's not impossible: for example, there could be an initial cap which would be sufficiently high to exempt say 75-80% of homes, but unindexed so that it would eventually impact on the majority of homes. Also there has been a suggestion that the cap should be the median home price per postcode (though personally I'm not sure that is equitable).
Yes it does seem tough on the current generation, especially those who won't be lucky enough to inherit from their Boomer parents. They have to pay their taxes to support the current pensioner generation, but by the time they get to age pension age, they will have saved sufficient via their compulsory super contributions (that effectively come off their own take-home pay during their careers) so that they won't be entitled to any age pension.

Thanks John, and apologies for my incorrect assumption that you hadn't considered the issue, and my incorrect insinuation that you supported the status quo! In terms of a workable solution I think any system that has different caps based on location will become too complex to administer. Particularly given that property has much less reliable and up to date valuation data than other assets. One flat cap of say $1M would be much simpler and more workable. Picking a largish number also makes it easier to rule out which properties clearly fall under it, and therefore don't require a valuation. The big opportunity to make progress on this issue which has not yet been seized, is greater publicity of the Pension Loans Scheme. It is one of the government's greatest policy initiatives in this space, and unfortunately one of its best kept secrets. It solves many of the real problems (and irrational objections) associated with means testing the home.

I afraid I still can't agree with you or BetaShares or the Barefoot HostPlus spruiker on retirement lump sums however. Angry young taxpayers will inevitably rise up and blow away all your assumptions about how much age pension will be available to supplement an individual's private retirement savings. No-one should be planning to rely on the age pension. They may be lucky enough to get it as a safety net if their savings plans don't work out, but they should plan to not need it in the first instance.

Hi Anon,
No probs! And I agree with your comments that a single cap would be simpler as well as (in my opinion) more equitable. I also agree with your views on the Pension Loans Scheme. When I was writing my book "Slow and Steady: 100 wealth building strategies for all ages" I included a strategy on use of the Pension Loans Scheme (Strategy 96 in my book) but while I was writing it I contacted the government department that administered it and they said that hardly any had been taken up. I think the issue in those days was that if you weren't receiving the full pension, you probably had significant assets, so it was natural to draw down those rather than borrow to support your lifestyle. Nowadays though there should be more use of the Scheme because the government allows you to receive up to 150% of the full age pension (it used to be only 100%).
It will be interesting to see what happens over the next three decades. I understand what you are saying about the demographics. I do think that the accumulated superannuation balances will grow enormously over the next couple of decades as the system matures, and that will ease the pressure on the age pension a lot. I don't know who's right - and it won't be until mid-century that we know. Actually, as a 63-year-old, I don't even care who's right, I'm just hoping to be alive in the late 2040's when we figure it out!

NZ has no problem paying all eligible retirees a standard basic aged pension, since 1938, all without any ridiculous asset or income tests. No hordes of pensioners clogging up Centrelink offices over the Tasman, unlike the disaster we see here.

The hordes at Centrelink are about to get much, much, bigger due to the cessation of grandfathered commissions. Lots of older Australians currently rely on their financial adviser to help them with age pension and aged care matters. They pay for this assistance via a small commission deducted from their superannuation. The amount paid is nowhere near enough to cover the adviser's time and excessive regulatory costs, but advisers do it because of the cross subsidy from other low involvement clients inherent in the commission system. That is all about to end, and Centrelink offices will be absolutely swamped.

Personally, I'll be telling anyone who can't afford the true cost of my advice to go and clog up the waiting room of their local federal member. Both Labor & Liberal have been instrumental in making professional financial advice much more expensive and harder to access. The politicians who created this problem need to hear first hand from the people affected.

Agree with you Steve. I know a lot of smart people who think NZ has done well: no super tax concessions but universal age pension. One possible way for Australia to go would be to make at least some (half?) of our Age Pension universal, but cut back on the generosity of the super tax breaks as an offset to the fiscal cost of the additional pensions. Transitions are always hard though and I reckon the political will is lacking.

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