$1 million v $500,000 and accepting a pension

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The article on why $1 million is always superior to $500,000 despite the potential loss of franking credits and age pension attracted many worthy comments. A reader, John Hyslop, asked about self-funding a retirement and staying off the age pension. John asked:

“This is a powerful analysis with great supporting graphics. Could you please run some numbers on two other couples?

Let’s use the same basic assumptions as in your article but with a different mindset. The couples have always been self-reliant. They realise that they have been fortunate to save well, with generous taxpayer help in tax concessions, and essentially tax-free retirement. They are concerned that coming generations are being asked to fund a great lifestyle.

They aim to refrain from being on the age pension for as long as possible can. They realise that they can live a good life on $50k p.a. They will avoid major house extensions or ‘unnecessary’ spending simply to qualify for the age pension. Although being forced to make annual withdrawals from their SMSF, they could build up another investment reserve fund outside super using any surpluses.

Could you re-run the numbers to assess when they ‘have to’ go on the pension and with the possibility of being able to leave some inheritance for the kids? I believe the system is unsustainable and is likely to produce inter-generational conflict.”

Hi John

Under age pension rules, a couple can have a home of unlimited value and receive a full age pension if their other assets are worth less than $380,500. The pension cuts out when assets exceed $837,000.

The couple with $500,000 will be eligible for a part-pension from the start which will make up half their annual income. The couple with $1,000,000 will start to receive a part-pension when they reach age 72 after drawing down some of their capital. Using the minimum drawdown rule would not impact the period until they become eligible for age pension because from age 65 to 75, the minimum drawdown rate is 5%, the same as the investment return.

The charts below show:

  1. Both couples will go on the age pension, unless they feel strongly that they should not be a ‘burden’ on the budget. This is typical of most retirees as even with compulsory superannuation since 1992, it is expected that 70% of Australians of eligibility age will still be drawing a part-pension by 2055 (see 2015 Intergenerational Report).
  2. When the Smiths become eligible for the age pension, they also receive their franking refunds (assuming not in an SMSF), and no longer need to drawdown capital to spend $50,000 a year.
  3. Due to the more modest lifestyle, neither couple runs out of other capital, so there will always be something in reserve for unexpected costs or a bequest.

It’s especially interesting to contrast the consequences of living on $50,000 versus $80,000 (in the previous article), with both couples trading off greater financial security for a lesser lifestyle, assuming money delivers lifestyle benefits.

Smiths ($1 million) versus Joneses ($500,000) based on $50,000 annual expenditure

Graham Hand is Managing Editor of Cuffelinks. My thanks to quantitative analyst Estelle Liu for assisting with the calculations.

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8 Responses to $1 million v $500,000 and accepting a pension

  1. Dudley April 13, 2019 at 8:21 PM #

    Until the home owning couple’s capital reduces to less than the asset test $840,000 limit the comparison is between the risk free Age Pension and a risk free investment.

    A home owning Age Pensioner couple with $0 capital receives a risk free $36,000 per year indexed to the highest of Wage, Consumer Price or Beneficiary Living Cost inflation.

    A home owning Self Funded couple with $1,000,000 capital earning 1% real risk free has an income of $10,000 per year. To receive risk free $36,000 per year they need $3,600,000 invested at 1% real.

  2. Graham Hand April 13, 2019 at 2:52 PM #

    Hi KW, Thanks for your comment. Please note, we are not licensed to give personal financial advice, and we don’t know your full circumstances.

    We also do not know the credentials of people who respond. They might not be properly qualified.

    A better approach would be for you to contact a good financial adviser.

  3. Graham April 22, 2018 at 10:03 AM #

    Hi Neil, assuming Labor is elected and can pass its plans, they announced a ‘pensioner guarantee’ that anyone on an age or disability pension will receive excess franking credits, including future pensioners. The date you mention (28 March 2018) specifically applies to SMSFs, where the SMSF must have had at least one member on a pension on that date to receive the franking credit refund. Disadvantages SMSFs. ‘Pensioner’ in this context does not mean a person with an SMSF drawing a pension from their fund.

  4. Neil April 22, 2018 at 7:26 AM #

    Just to clarify, my previous comment is assuming the ALP form government and get its changes passed. My understanding might be wrong; that a person who was receiving an Age pension on the day the changes were announced keeps ALL franking credits. If one BECOMES an Ap after that one does not.

    • Laine April 22, 2018 at 3:03 PM #

      Neil

      Any aged pensioner will still receive the full franking credits on their individual income with any excess refunded as cash. This is regardless of when they first became (or become) an aged pensioner.

      Any aged pensioner who was a pensioner as at 28 March this year will also continue to receive the excess franking credits within their SMSF.

      If you were not a pensioner at that date but later become one, you will receive the refund of unused franking on your individual income but not within your SMSF.

      All this applies to a change in the system which is not yet law and may never become law.

      There is also talk of them backdating their proposed changes to capital gains tax so the new rate affects any property bought from 1 July 2017.

      Does this mean theat if you buy in 2017 and sell in 2018 after holding for more than one year and the ALP form govt in 2019 they can come back and charge you extra tax ???

      How can anyone plan anything with these sorts of ad hoc and back dated policies.

  5. Neil April 22, 2018 at 7:19 AM #

    “When the Smiths become eligible for the age pension, they also receive their franking refunds (assuming not in an SMSF),”? How So? There is no return of franking credits other than to offset tax liability.

  6. Mark Reynolds April 19, 2018 at 11:18 AM #

    Is it just me, or is the assumption about franking credits “becoming available again once on the aged pension:, an acceptance by the author that the current government is doomed, and labor is set to win the next Federal election?

  7. Bill Buttler April 19, 2018 at 10:43 AM #

    Thanks for this article. It’s great to read something aimed at the man in the street for a change. $500k is a realistic target for most employed Australians, who cannot hope for the luxury of being able to live off income in perpetuity. However, there is a major qualification in the shape of the planning risk of relying on the continuation of current Age Pension eligibility rules.

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