Pension power: Don’t ignore it

New research finds the mere presence of a government old age pension is a boon for all older investors.

In Australia, we are lucky to have a strong pension system, which is often under-appreciated by investors. Yet research shows that when things get difficult, the safety net of a government pension is actually a distinct advance to all investors. 

New research from actuarial firm Milliman says the wealthy benefit more than the rest of us in turbulent times because depending on their super balance, their lifestyle can be supplemented with a new form of income in the age pension if their wealth drops.  In contrast, retirees currently on the full pension cannot receive more age pension when their super drops, so they just experience a drop in overall retirement income.

This may come as comforting news in a year that has seen superannuation balances oscillate wildly with the ASX down 14 per cent from its ­February highs.  

By far, the hardest hit older investors are those who hold strong banking exposures in their portfolio, with dividends slashed and share prices of the big four, such as NAB, down over 30 per cent.

No wonder some self-funded retirees have handed in their badge and applied for the age ­pension, given the attractiveness of the annuity-style fortnightly income and the ancillary benefits worth thousands of dollars per year.

The Milliman report found that the cashflow of wealthy retirees declines less in times of falling sharemarkets, compared with the cashflow of the average retiree. For a 65-year-old couple with $1m in super, Milliman analysis shows that a 30 per cent drop in their assets may result in accumulated lifetime Centrelink payments of about $500,000. 

The lower the superannuation account balance, the more the age pension entitlement increases, resulting in the overall ­income staying relatively stable until the super account balance drops to the threshold for the full age pension (currently $401,500 for a homeowner couple). 

Wade Matterson, practice leader with Milliman, says: “The age pension can provide immense value to retirees. However, they may still experience a poorer retirement as future investment returns vary, not to mention the psychological damage created through the scale of the social and financial crisis that is currently unfolding. There is also a risk that the rules around age ­pension eligibility may change.” 

The implications of Milliman’s analysis are twofold. The first is for pre-retirees working out how much they should save for retirement.

As a financial adviser, I recommend people think about how much they would spend if they had no mortgage and no child-related expenses.

This generally results somewhere between $50,000 and $80,000 a year. Using the median expenditure figure of $65,000 and assuming 6.5 per cent super returns each year, the goal would be to save a $1m super nest egg.

The rationale is that the retiree lives off the $65,000 a year in super returns, while their capital remains intact throughout their lifetime.

But for those who will not reach the magic $1m superannuation balance, the Milliman analysis shows that $400,000 is the “sweet spot” for retirees who own their home and have a partner.

As such, pre-retirees only need to save enough super to be at the threshold of a full age pension to enjoy a retirement that matches — in terms of ­annual income — people who have more than double their level of savings. (This assumes the ­retiree does not wish to spend any capital that forms the basis of their annual income.)

 Centrelink has different asset test thresholds depending on whether you own a home and whether you are single. To receive the full age pension, assets must be less than $268,000 for a single homeowner, $482,500 for a single non-homeowner, $401,500 for a couple homeowner and $616,000 for a couple non-homeowner. 

It may be wise to aim for super balances say 25 per cent above the “sweet spot” to allow for sharemarket drops. In other words, to maximise retirement income, a homeowner couple might look to accumulate about $500,000 in super rather than the “sweet spot” of $401,500 to allow a buffer for falling sharemarkets or one-off withdrawals such as holidays and renovations.

The second implication of the Milliman analysis is that retirees who are just beyond a part age pension could consider taking slightly more investment risk knowing they have the age pension as a safety net if their portfolio drops in value.

James Gerrard is principal and director of Sydney financial planning firm financialadvisor.com.au