When working longer makes little sense

Working for longer should boost your income, but for some the pension system means it’s hardly worth it. Here’s how to find your retirement sweet spot.

The aged care pension system means staving off retirement may not be the best call for your finances.

It would be entirely logical to assume that the longer you work, the more you can put into super.

However, for a group of people within a certain band of assets, working longer may actually be detrimental to retirement planning, and finishing up work may actually be the best thing to do financially.

The concept of the retirement sweet spot has been around for a while and involves optimising your finances so you get the best of both worlds. The retiree enjoying the sweet spot is partially self funded with a regular superannuation pension payment while also receiving the maximum government age pension. This combination of income elevates their total retirement cash flow to a level which far exceeds the amount of capital they have.

In terms of when you can get the age pension, it was originally provided to women at age 60 and men at age 65, however over the last 20 years the age threshold has increased and now stands at age 67 for both men and women. And the amount payable is significant — singles receive up to $29,874 and couples up to $45,037 per year.

That said, there are strict income and asset tests which need to be met to qualify for these benefits. As a guide, a couple who own their home with less than $470,000 in assets are eligible for the full age pension under the assets test, while a single homeowner can have up to $314,000 in assets.

Central to the strategy: understanding centrelink’s age pension rules and shaping your assets and income to sit just below the threshold to maximise your entitlement.

Apart from your home and some minor items such as prepaid funeral costs, almost everything you own needs to be accounted for by Centrelink when working out your eligibility. Cars, contents, bank accounts and super are all common assets which form part of the assets test.

If you exceed the cap it is not the end of the world, however, your age pension entitlement will reduce on a sliding scale to a point where the entitlement drops to zero. For instance, if the assessable assets of a homeowner couple exceeds $1,047,500, then their age pension entitlement is lost completely.

It is not unheard of to be penalised by the pension system for working longer.

Oddly, there are a few quirks of the system where people are penalised by working longer rather than retiring.

Take a person in their late 60s who is working full-time as an administration assistant earning $65,000 per year. Due to this level of employment income, based on centrelink’s income test they are only eligible for a $5 per fortnight age pension payment. If the person decides to stop working they will immediately start to receive $1149 per fortnight in age pension payments, assuming they are under the assets test threshold.

While it is true $65,000 per year in wages is more than $29,874 per year in age pension payments, when you break down the numbers it might make some people start to rethink the financial benefits of continuing to work. After income tax, $65,000 in gross wages becomes $53,437 in net pay, meaning the difference between working and not working for this person is only $23,563 less income per year.

Given a typical full-time employee works 1800 hours per year, if the person stops working they will start to get the equivalent of $16 per hour from the government via the age pension. If the person continues to work full-time, they will get paid a net wage of $29 per hour. In other words, the person is only working for an effective hourly rate of $13 per hour, being the difference between what they actually get paid for working and what they could get as the age pension if they stopped working.

The Grattan Institute has been vocal in its view that Australia faces a long-term structural budget deficit as more people retire and live off the government purse and less people remain in the workforce and pay income tax.

So, it seems encouraging older Australians to work for longer is a smart move and both major political parties support this in principle. However, current social security rules do not provide sufficient incentive. In fact, it could be argued it provides a disincentive.

Turning our attention to the assets test, take a retired couple in their early 70s who own their home and have combined assessable assets of $500,000. Assuming they meet the income test, their total fortnightly age pension payment would be $1642 which is just under the maximum amount. If one of the partners does a bit of part-time work and generates $20,000 in income and decides to contribute it into super, their assessable assets increase to $520,000 and their fortnightly pension reduces to $1582.

The reduction in age pension payment for the couple, due to the extra $20,000 in assessable assets, is $60 per fortnight which is $1560 per year. To try and recoup this lost $60 per fortnight age pension payment, the extra $20,000 in super needs to generate 7.8 per cent investment return.

While this is possible if a balanced or growth style fund is selected within the super account, if the retirees chooses a more conservative investment option such as the ‘stable’ strategy with Australian Super, the 10-year average return is less than 5 per cent per year. This results in the retiree being worse off from a cash flow perspective if they decide to work and put the $20,000 of wages into super. The optimal thing to do would be for them to kick back and enjoy the fortnightly age pension payments and forget about working.

Because the reality here is the more they work and save, the less they get from the government.

The rules are stacked against lower and middle class Australians who wish to continue working beyond the age pension start date at age 67 — the financial incentive to do so is sorely lacking

James Gerrard is a director and principal at www.financialadviser.com.au