Making a Valid Comparison of Private Means

Introduction

This paper sets out two approaches to the matter of comparing private means in the form of a defined benefit superannuation pension, with private means in the form of assets that are driving an allocated pension. The first approach compares the actuarial valuation factor for a Super SA defined benefit pension with factors obtained using the asset and income test values corresponding to a range of part age pension entitlements. The second approach is through use of a concept called ‘equivalent private means’ defined in the relevant section below.

Part A: Comparing an Actuarial Valuation Factor with Means Test Values

The actuarial valuation factor for a Super SA defined benefit superannuation pension being paid to a 65 year old male is 13.1 and to a female of the same age is 14.5 (average for males and females is 13.8) This tells us an actuary has determined that, for a male aged 65 y each $1,000 of annual pension requires 13.1 x $1,000 = $13,100 to fund it. Actuaries are well known to be very conservative in estimating the cost of pensions and so it seems reasonable to say that this $13,100 figure is more likely to be an overestimate of the pension value than an underestimate.

The age pension means testing rules create pairs of asset and income values which give people the same age pension entitlement. In Table 1 the income and asset value pairs corresponding to a set of three part age pension entitlements (10%, 50% and 90% of a full age pension) are displayed. The financial asset value for each part age pension entitlement has been divided by the corresponding assessable income value to obtain a ‘Means testing valuation factor’. In Table 1 the age pension amounts are those paid as the couples commence age pension.

Table 1

Part age pension value expressed as a % of a full age pension
10% / 50% / 90%
Income value*
a)Gross Pension
b)Assessable Income / $56,700
$53,865 / $34,500
$32,775 / $12,300
$11,685
Asset value**
a)Total Assets
Financial Assets / $860,410
$800,410 / $590,026
$530,026 / $319,641
$259,641
Means testing valuation factor
(Financial Assets/Gross Pension) / 14.1
(800,410/56,700) / 15.4
(530,026/34,500) / 21.1
(259,641/12,300)
Actuarial valuation factors for a Super SA defined benefit pension / 13.1 (male, age 65y) 14.5 (female, age 65y)

*Super SA pensions often have a small component that is not counted in the income test and this has been assumed to be 5% of the pension’s gross value. The age pension entitlement is calculated using the smaller assessable amount.

**Total assets are used when age pension entitlement is calculated and it has been assumed that the couple has $60,000 of ‘personal effects’ assets that do not produce income. This ensures that the calculation of Means testing valuation factor is done using an income value higher than the assessable income and an asset value smaller than the total assets.

Discussion of Table 1: . at the outset here we remind ourselves that an important aim of means testing is to see that people with similar private financial means receive similar amounts of income support.

The value of 21.1 for the Means testing valuation factor in the right hand column of Table 1tells us that where an asset tested couple commence age pension receiving 90% of a full age pension they can hold financial assets 21.1 times as much as the annual income of a Super SA defined benefit pension couple who are income tested and get 90% of a full age pension because their income is $12,300 p.a. (with $11,685 being counted). The actuarial value of the Super SA pension is no more than 14.5 x $12,300 = $178,350. Clearly the $259,641 held by the asset-tested couple is capable of providing them with more than $12,300 p.a. (indexed) for their remaining lifetimes. So the current means test settings see this asset tested couple commencing their age pensions with the same level of income support as a defined benefit couple having smaller private means.

This also applies where two couples commence their age pension with an entitlement that is 50% of the full age pension. For the 10% case the value of the Means testing valuation factor (14.1) is about the same as the actuarial factor (13.1 for males, 14.5 for females, 13.8 average for males and females).

This analysis points clearly to the conclusion that over most of the range of income/assets that allow receipt of an age pension payment asset-tested people, at the commencement of their age pension, get the same level of income support as income tested people of lesser private means.

In this discussion care has been taken to state the age pension payment as that received at the time an age pension payment commences. In the second part of this paper the comparison of the income and asset tests is made over a twenty year period.

Part B: The Working of the Means Tests Over 20 Years

The approach to the comparison of the relative severities of the income and assets tests taken in this section makes use of a concept called ‘equivalent private means’ which is defined as follows.

A couple or single person receiving an age pension payment determined under the assets test has ‘equivalent private means’ to another couple or person receiving an age pension payment determined under the income test, if

  1. the initial age pension payment is the same in each case and
  2. the assets of the asset-tested couple or single person are just sufficient to provide each year, for twenty years, the same total income as the income-tested couple or single person receives.

If condition 1 above is met but the asset-tested couple have reduced their financial assets to zero after 20 years, the income-tested couple will be recognized as having the greater private means. But where condition 1 is met, and after 20 years the asset-tested couple has financial assets remaining, then the asset-tested couple will be recognized as having the greater private means. This approach complements that set out in Part A

Discussion

The ‘equivalent private means’ approach to comparing the income and asset tests (in particular, the withdrawal rates for the two tests) is more robust than the very superficial comparison of income and asset testing made in the Harmer review. The Harmer review made a single point comparison (the initial age pension payment) between income and asset testing and used it to support an assertion that asset testing was more severe than income testing once the assets held exceeded about $310,000, including $60,000 of personal (non-income producing) assets. No attempt was made to take account of the total income that people would have.

This current analysis using the ‘equivalent private means’ concept makes a 20 year comparison which is displayed in Table 2. The comparison is made between an asset-tested couple and an income-tested couple both of whom have an initial entitlement to 50% of a full age pension and both couples have the same total income each year. The income tested couple is in receipt of a defined benefit pension such as members of the South Australian pension scheme, and members of all the Commonwealth schemes, receive. Both couples are homeowners.

Assumptions for Table 2

a)for the asset-tested couple: as well as the allocated pension account balance there is an additional $60,000 of personal (non-income producing assets) and the allocated pension earning rate is 7%

b)for the income-tested couples: 95% of the defined benefit pension amount is counted as income and the pension is indexed at 2.5% p.a. (CPI).

c)for age pension: the maximum rate for the basic age pension is indexed at 4% p.a. (CPI + 1.5) and the age pension supplement is indexed at 2.5% (CPI). Income test withdrawal rate $0.50, asset test withdrawal rate $1.50

Table 2: Retiree experience over a 20 year period when the initial age pension payment is 50% of a full age pension and total incomes are the same every year.

Asset-tested Couple relying on an allocated pension / Income-tested Couple relying on a defined benefit pension
Years elapsed / Account balance / Pension Drawdown / Age Pension / Total Income / Gross Pension / Age pension / Total Income
0 / 530026 / 34500 / 13174 / 47674 / 34500 / 13174 / 47674
5 / 528895 / 35649 / 18568 / 54217 / 38082 / 16135 / 54217
10 / 519385 / 36944 / 26804 / 63749 / 43086 / 20663 / 63749
15 / 498549 / 38017 / 37037 / 75054 / 48748 / 26307 / 75054
20 / 463391 / 38779 / 49701 / 88480 / 55153 / 33327 / 88480
Average annual age pension over 20 y as a percentage of a full age pension / 72% / 56%
Total Age Pension Paid In 20 y / 581828 / 438699

It can be seen from Table 2 that:

  • after 20 years the allocated pension couple retains a large fraction of their original allocated pension account balance and so, according to the criterion we are using, this couple has much greater private means than the income-tested couple.
  • over the 20 year period the average percentage of a full age pension paid annually to the asset-tested couple is expected to be significantly larger than that paid to the income-tested couple (72% vs 56%)
  • in dollars, over the 20 year period the asset tested couple is expected to receive $581,828 - $438,699 = $143,129 more than the income-tested couple.

The story that the numbers in Table 2 tell can be expressed in words as follows:

a couple deriving income in the form of an allocated pension drawn from an account with a starting balance of $530,000 initially receive the same age pension as another couple having income in the form of a $34,500 p.a. CPI-indexed defined benefit pension. But over a 20 year period, during which both couples maintain the same total income, the age pension amounts paid to the allocated pension couple run ahead of those paid to the defined benefit pension couple. After 20 years the allocated pension couple still retain a substantial account balance.

It is worth noting that even when an income-tested couple derives its income from employment, and can make use of the work bonus, the advantage enjoyed by the asset-tested couple still remains.

Calculations have also been performed for an income test withdrawal rate of 40 cents. With this withdrawal rate the defined benefit pension that gives a couple a part age pension equal to 50% of a full age pension is $41,400 and to obtain the same total income the allocated pension couple must draw down their account at a greater rate than shown in Table 2. However, after 20 years they still have a substantial account balance and, over the 20 year period, the age pension payments they receive compared to the defined benefit pension couple are still larger.

Finally calculations have been done to cover situations where the couples compared have private means large enough to reduce their initial age pension entitlement to 10% of a full age pension and small enough to increase it to 90%. In every scenario tested the results were of the same form as for Table 1 leading to the conclusion that the income test was already more severe than the asset test when the income test withdrawal rate was $0.40 even for asset amounts at, or near to, the point at which entitlement to age pension is extinguished. This is a strikingly different assessment from that given to the Government in the Harmer Review.

Superannuation pensions paid to South Australian, West Australian, Tasmanian and Commonwealth superannuants, are untaxed source pensions (in Tasmania 30% of the pension is taxed source and 70% untaxed source). Consequently, many of these people who are part age pensioners will be paying tax and the medicare levy on their incomes whereas part age pensioners receiving private income in the form of allocated pensions will not usually pay tax or the medicare levy. This makes it all the more unacceptable for the age pension income test to be more severe than the asset test as far as these people are concerned.

It seems reasonable to assume that calculations analogous to those described above (i.e. calculations covering an extended period) are being made regularly by the Treasury and/or by the Department of Families, Housing, Community Services and Indigenous Affairs. This raises the question of what use, if any, was made of such calculations when the decision to tighten the income test, and leave the asset test unchanged, was taken.

The analyses outlined here leave little room to doubt that age pension income testing is more severe than asset testing and was already more severe before last year’s age pension reforms which saw tightening of the income test but no change to the asset test.

Dr Ray Hickman for S.A. Superannuants

February 2010

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