Should we make pensions reversionary now?
In light of 1 January 2015 changes to the income tests for age pensions and the Commonwealth Seniors Health Card – should we make pensions reversionary now? The answer may surprise you.
When I first read the legislation, I would have answered yes to this question. But having now done some modelling on it I’ve concluded that quite often, the answer will be no.
Of course there are many reasons people make pensions reversionary – any that were valid before remain entirely valid today. Our interest in this article is whether or not the changes to the income tests for the age pension and Commonwealth Seniors Health Card change the debate.
The reason they might is that both changes (from 1 January 2015) result in deemed income from superannuation pension assets being counted towards the income test for these benefits. (The deeming rules are the same as the normal age pension deeming rules for financial assets – pension balances are assumed to earn income at 2% up to a fairly low threshold and then 3.5% thereafter).
For the age pension, this often compares unfavourably to the current method at least in the short term. In other words, the new deeming approach will often mean more income counts for the age pension income test, often resulting in a lower age pension.
For the Commonwealth Seniors Health Card, the comparison is even more stark – currently superannuation pensions are entirely ignored for the income test for this card and so many self-funded retirees enjoy the card, despite having very large superannuation balances.
In both cases, there are grandfathering provisions that see the current treatment continue beyond 1 January 2015 under certain circumstances. Among other things, a pension in place before 1 January 2015 must continue uninterrupted to keep the grandfathering. This raises the question: should we make pensions reversionary now to make sure that the grandfathering continues as long as possible?
Our “not necessarily” response comes from two sources.
Firstly, while the age pension changes include special rules extending the grandfathering beyond the death of the primary pensioner when a pension is reversionary, the Commonwealth Seniors Health Card changes do not. In other words, making a pension reversionary will have no impact on how long a couple can exclude their superannuation income from the Commonwealth Seniors Health Card. Given that a large number of SMSF members receive this card rather than the age pension, this will be a key consideration.
Secondly, our modelling suggests that for the age pension, grandfathering is useful in the early years but not necessarily indefinitely. For many clients, there will come a point where the deeming actually gives a better result than the current treatment, driving a deliberate switch to the deeming rules. This means we should question the value of doing something now (eg making the pension reversionary) where the sole benefit is the ability to continue the grandfathering for a really long time – by the time the client gets there it might just not be worth anything!
If a client could change to a reversionary pension with no downside, it would still be worth doing just on the off chance that it was valuable. However, the current income test rules actually penalise those who start a pension with a reversionary beneficiary if they have a longer life expectancy than the primary pensioner. The net effect is that re-setting to include a reversionary pension might result in a lower age pension right now – in return for a higher one (maybe) down the track. Will it stack up? Our modelling suggests that often it won’t.
Meg Heffron is head of customer at Herffron SMSF Solutions. Ms Heffron will be speaking at the 8th Annual SMSF Adviser Strategy Day - for more information, please click here.