Retirement Income Strategic Issues Paper
Some features of the current means tests result in an unequal treatment of pensioners with similar levels of private means. These features, in combination with the tax system, can influence people's choices about the form in which they hold assets. Inconsistencies in scope between the income and assets tests also reduce system coherence.
A single means test which removes the assets test and extends the income test by extending deeming to a greater range of assets would have the potential to improve the fairness and coherence of the retirement income system. Under this approach, key design parameters could include:
- a consistent approach across a broad range of assets;
- an allowance for a reasonable level of personal assets, such as household furnishings, jewellery and motor vehicles; and
- concessional treatment of income from employment, to improve incentives to undertake paid work.
Owner-occupied housing provides important economic and social benefits to retirees and should continue to be generally exempt from pension means testing. However, to increase the fairness of the pension system, consideration should be given to setting a limit (at a high level) on the value of the exemption provided in respect of owner-occupied housing.
Recommendations for a single means test and its interaction with the broader tax-transfer system will be included in the Panel's final report. The means testing of pensions is closely associated with broader considerations relating to the taxation of income and assets and the overall progressivity of the tax-transfer system. The feasibility of a single means test will depend on consideration of administrative and delivery issues, as well as the distributional impacts of such an approach.
The Age Pension means test determines the rate of payment that Age pensioners receive. The pension means test has two parts: an income test and an assets test (Chart 6.1). A person's pension is calculated by applying the test that results in the least pension.
- The income test applies a 40 per cent taper to income above a threshold ($3,588 per annum for a single person). It applies directly to earned income, but uses a variety of methods to assess income from savings. A part pension is payable to a single person with private income up to around $41,000.
- The assets test includes most assets, with the principal home exempt (and a higher assets test free-area for non-home owners). The assets test reduces Age Pension receipts by $1.50 per fortnight (or $39 per year) for every $1,000 of assets over the free-area. A pension is payable to a single homeowner with assets in addition to the principal home up to $555,750.
- Superannuation accumulations (not being drawn down through an income stream) are treated as financial assets.
Around 41 per cent of pensioners currently have their rate reduced by the means test — 32 per cent by the income test and 9 per cent by the assets test — with the role of the assets test increasing over time. However, for most pensioners, the reduction in the rate of the pension as a result of means testing is relatively small — around 73 per cent of pensioners receive over 90 per cent of the maximum pension rate and only 3 per cent receive less than 25 per cent of the maximum rate.
Assessing the effectiveness of the existing means test
The two tests treat savings differently and, within the income test, the treatment of savings can differ depending on the form in which it is held. This means that individuals with similar levels of wealth can be paid different rates of Age Pension. For example, while a person may have their pension reduced under the income test because they hold income producing assets in their bank accounts or in a share portfolio, a person holding assets of the same value in non-income producing holiday houses, art collections and jewellery would not have their pensions reduced under the income test.
The assets test can create relatively high effective marginal tax rates on income from savings. A pension reduction of $1.50 per fortnight per $1,000 worth of assets over the asset test threshold equates to an effective marginal taper rate on income of 78 per cent, assuming a 5 per cent annual income return. Effective marginal tax rates will vary depending on asset holdings and the assumed rate of return.
Further, some treatments of financial assets within the income test (for example, the calculation of assessable income from purchased superannuation income streams) do not reflect the actual flow of income that pensioners receive from these investments.
As a consequence, means testing is not as equitable as it could be. It may also create disincentives for the productive use of assets, with potentially adverse effects on economic efficiency and the long term sustainability of the Age Pension system.
The means tests also interact with the taxation system in complex ways, producing in combination a wide range of effective tax rates, and this also is less fair and coherent than it could be.
An alternative approach
An alternative single means test should:
- ensure the full range of an individual's retirement savings is effectively and fairly assessed in the pension means test;
- be more neutral in the treatment of different forms of retirement savings;
- ensure there are appropriate incentives for people to use their retirement savings effectively;
- provide appropriate incentives for older Australians who wish to continue to undertake paid work; and
- contribute to the fairness of the overall tax-transfer system.
This could be done by effectively extending the current 'deeming' approach to superannuation and non-financial assets, such as personal effects, holiday homes, land and collections.
However, several important issues would need resolution:
- appropriate deeming rate(s), given the level and diversity of assets;
- whether assets should be deemed or whether account should be taken of actual income streams;
- the structure of the free-areas, including the treatment of personal assets;
- the appropriate treatment of non-commutable income streams;
- the extent to which employment-related income is treated concessionally to promote workforce participation;
- the taper rates that best achieve balance between incentives to work and save, effective targeting and fiscal considerations; and
- the appropriate assessment of businesses and trust structures.
The ultimate design of such a means test would also depend on its interaction with the personal income tax system. The Panel will be seeking to better integrate the operation of the means test with the personal income tax system and, where possible, reduce the likelihood of an individual having to interact with both systems.
Owner-occupied housing plays an important role in Australia's retirement income system.
- It is part of lifecycle income smoothing. In retirement, home owners save on rental costs, freeing up their income for other consumption.
- It is frequently used by retirees as a form of longevity insurance. The capital value of a home can be used as a 'backstop', including as a source of funding for residential care, if they outlive their other savings.
- Home ownership provides a range of benefits above the pure rental value of the housing, including security of tenure and living in the same neighbourhood for a long period of time. These are important for the social integration and participation of retirees.
The great majority of retirees are home owners and the adequacy of pensions has been determined on this basis (with renters receiving separate assistance). Savings invested in owner-occupied housing generally do not generate cash-flow incomes. For these reasons, the Panel supports the continued exemption of owner-occupied housing from the pension means test. However, the provision of an uncapped exemption provides an opportunity for very high levels of wealth to be sheltered from means tests. To increase the fairness of the pension system, the Panel proposes in the development of the new means test to give consideration to setting a limit on the value of the exemption of owner-occupied housing.
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