Clock is ticking for account-based pensions
The financial cost of not starting an account-based pension before the deadline will be a lot higher than the cost of receiving advice.
At the time the Labor party lost the federal election, there was a plethora of superannuation legislation that had not been passed. These policies were truly a mixture of the good, the bad, and the ugly. One that firmly fits into the bad category, a proposed changed to the treatment of account-based pensions by Centrelink, looks like it has been given the kiss of life by the Coalition.
Shortly after taking office, the Abbott government announced the policies they would drop, policies and legislation that would be amended, and policies that would be introduced as legislation. Thankfully, the ugly policy of taxing account-based pensions that earned more than $100,000 in income was dropped.
The bad news is a policy to have account-based pensions counted by Centrelink as an asset for deeming purposes has been adopted by the Abbott government. The good news is that the change in treatment of account-based pensions will only apply to those taken out after 31 December 2014.
Under the current Centrelink rules, a person of age-pension age has the value of their superannuation counted under the assets. Under the income test, the treatment differs depending on whether the superannuation is in accumulation phase or pension phase. Superannuation accounts in accumulation phase have the deeming rules applied to them.
Accounts in pension phase have a modified income test applied. This means that the amount of pension received is decreased by its purchase price. Decreasing the income a person receives by its purchase price has been a time-honoured practice for superannuation pensions and other annuities.
Over the life of an account-based pension, due to the increasing minimum pension rates that must be taken, it is expected that the principal component of the superannuation account will be drawn down over time.
The amount of purchase price deducted is calculated by dividing the value of the superannuation account, at the time the pension is started, by the member's life expectancy. Even with the current low deeming rates that apply the current treatment of account-based pensions produces a lesser amount than is assessed as income by Centrelink.
An example of how this works is Kevin Abbott, who retires at age 65 in November 2014. At that time, he commences an account-based pension from his $400,000 super fund account. Not long after starting the account-based pension, Kevin applies for the age pension.
When Kevin started the account-based pension his life expectancy under the current tables is 18.54 years. This results in an annual purchase price of $21,575. If Kevin draws an account-based pension at the minimum rate of five per cent of $20,000, after allowing for the purchase price of $21,575, no income is assessed by Centrelink under the income test.
Under the proposed change to the income test, account-based pensions commenced after 1 January 2015 will have the deemed earning rates applied to the member's balance each year. Unfortunately, the current treatment of account-based pensions will only apply to those that have been commenced prior to 1 January 2015 by someone who is either receiving the age pension or another Centrelink income benefit at that time.
If Kevin had not retired in November 2014, but instead retires in January 2015 and starts an account-based pension then, he would be caught by the new legislation and the value of the superannuation counted under the deeming rules. This would mean that if Kevin had financial investments in addition to his superannuation that exceeded the low deeming rate, Centrelink would count $14,000 of deemed income for his account-based pension under the income test.
This change in the legislation presents proactive financial planners with a real opportunity. Clients should be contacted between now and the January deadline who are aged 65 or older, have large amounts in superannuation accumulation accounts, have other income such as dividends or taxable superannuation pensions from untaxed funds, and they should be made aware of the changes that will apply from 1 January 2015.
The financial cost to a retiree of not starting an account-based pension before the deadline, that results in them not being eligible for at least one dollar of the Centrelink age pension due to the amended income test, will be a lot higher than the cost of receiving advice.
Max Newnham, owner, TaxBiz Australia