Grandfathered account-based pensions
By Mark Gleeson, Senior Technical Services Manager
When providing advice about a client’s account-based pension (ABP), it’s important to consider the grandfathering status for Centrelink purposes. Reduced deeming rates effective from 1 May 2020 may require a revisiting of the benefits of grandfathered ABPs. Further, more clients may qualify for the Commonwealth Seniors Health Card (CSHC) with reduced deeming rates and lower ABP balances following the downturn in investment markets caused by the Coronavirus.
Grandfathering of an ABP for social security payments
To qualify for grandfathered status in relation to social security payments:
- the ABP must have commenced before 1 January 2015, and
- the ABP recipient was receiving an income support payment immediately before 1 January 2015, and
- since 1 January 2015, the ABP recipient continues to receive an income support payment.
Qualifying income support payments include many social security pensions and payments, for example, Age Pension, Disability Support Pension, Carer Payment (but not Carer Allowance Payment) and the Jobseeker Payment (formerly Newstart Allowance). The client does not need to be receiving the same payment since 1 January 2015, but there must be no breaks in the receipt of income support payments.
The deeming rate changes
When deeming first applied to non-grandfathered ABPs on 1 January 2015, the lower and upper deeming rates were 1.75% and 3.25% respectively. Since then, the rates have continued to reduce. From 1 May 2020, the lower and upper rates will be 0.25% and 2.25% respectively.
When clients draw a small pension from their grandfathered ABP they may have a more favourable income assessment compared to a similar deemed ABP. Conversely, where large amounts are received from the ABP, deeming may provide a better outcome. The reduced deeming rates may create more situations where a deemed pension is more favourable than a grandfathered pension. Advisers should check whether the client is assets tested or income tested. Only income tested clients are affected by changes in the income assessment of ABPs.
Case study – homeowner couple
Blake and Jenna, both age 72, are income tested aged pensioners. Blake has an ABP with a current balance of $370,000. The ABP was commenced in August 2014 and qualifies for grandfathering under the Centrelink income test. Let’s assume they have $20,000 in personal effects and $15,000 net assessable income from Jenna’s defined benefit pension. Blake is currently receiving $35,000 per year from the ABP.
The income test assessment of Blake’s grandfathered ABP is as follows:
| Annual payment less deductible amount|
= annual payment less (purchase price less total commutations) / life expectancy at commencement
= $35,000 less ($400,000 less nil) / 18.54
We have sourced the purchase price ($400,000), total commutations (nil) and life expectancy at commencement (18.54) from the Centrelink schedule, also known as the details of income stream product form.
The couple currently receive Age Pension of $515.48 per fortnight (pf) each ($13,402.55 per year each). The income test determines the assessment for the couple.
If Blake rolled over his ABP to a new provider, the grandfathered status would be lost and the new ABP would be deemed. Let’s apply the new deeming rates to Blake’s new $370,000 ABP. For simplicity, we assume no other deemed investments.
Balance of $283,800
= 0.25% x $86,200|
= 2.25% x $283,800
The deeming on the new ABP ($6,601) is significantly lower than the current income test assessment ($13,425). Consequently, the couple’s estimated entitlement increases to $581.10 pf each ($15,108.55 per year each). By losing the grandfathered status and taking advantage of the new low deeming rates, the couple have increased their Centrelink entitlements by $65.62 pf each ($1,706 per year each).
Before rolling over a grandfathered ABP, advisers should consider the client’s existing product in respect of its features, fees, investment options, death benefit nominations and other considerations. Once a pension has lost its grandfathered status, it can never be regained. In our case study, Blake may also wish to consider retaining his existing ABP and reducing the pension drawdown. This approach can increase Centrelink payments and reduce depletion of capital.
Grandfathering of an ABP for the CSHC
Similar grandfathering rules apply for the CSHC. A client who commenced an ABP before 1 January 2015 and held a CSHC on 31 December 2014, will not have their ABP included in the income test provided they:
- continue to hold a CSHC, and
- retain the same ABP.
If the client ceases to hold a CSHC for any period of time, their ABP is deemed if they become a CSHC holder again. Generally , if they purchase a new ABP, or roll over into a new ABP, their new ABP is deemed.
Grandfathering arrangements do not apply to the Low Income Health Care Card. All ABPs, regardless of their commencement date, are deemed for the Low Income Health Care Aard.
More clients potentially eligible for CSHC
The combination of lower ABP balances, due to the downturn in investment markets, and the reduced deeming rates results in more clients potentially being eligible for the CSHC under the income test. You may wish to recommend that new or existing clients apply for the CSHC if they do not hold the card.
To qualify for the CSHC, adjusted taxable income must be below the current relevant threshold:
- $55,808 per year for singles
- $89,290 per year for a couple, based on combined income
- $111,616 per year for illness separated couples, based on combined income.
The thresholds above are indexed every 20 September and also increase by $639.60 for each dependent child.
The definition of income for the CSHC includes:
- taxable income
- target foreign income
- total net investment loss
- assessable fringe benefits (a modified version of reportable fringe benefits)
- personal deductible contributions and reportable employer superannuation contributions (generally salary sacrifice contributions)
- deemed income from non-grandfathered ABPs
Clients can hold substantial amounts in a non-grandfathered ABP and still qualify under the income test based on the new deeming rates. To illustrate this, for a single person to have $55,808 deemed income (the current threshold for singles), an amount of approximately $2.5 million would need to be held in a non-grandfathered ABP. The transfer balance cap of $1.6 million (2019/20) would generally restrict such an amount.
Some tips to remember for the CSHC:
- Deeming only applies to non-grandfathered ABPs. Unlike the normal Centrelink income test, deeming does not apply to bank accounts, term deposits, managed investments and direct shares. The actual taxable income (if any) generated by these investments may have an impact under the CSHC income test.
- Contributing to super (for those who are eligible) provides an opportunity to move assets into an environment that doesn’t generate taxable income. Deeming does not apply on accumulation phase interests for the CSHC income test.
- Clients close to, or above, the CSHC income test may roll part of any deemed ABP back to super (accumulation phase) which is not deemed.
- An investment bond can help to reduce the amount of taxable income and may be a useful strategy to become entitled to the card. The additional tax payable in the bond and the possibility of assessable withdrawals should be considered before recommending this strategy.
- Centrelink/Department of Veterans’ Affairs apply an income test to a reference year, which is usually the tax year immediately preceding the current tax year. If a notice of assessment (for tax purposes) has not been received for the reference year, the tax year immediately preceding will become the reference year. The balance of any non-grandfathered ABP is deemed using the person’s latest super statement.
Case study – single CSHC
Cally, age 66, is single and she wants to apply for the CSHC following the large drop in her ABP current balance. You have identified her current sources of income as follows:
Defined benefit income|
– Taxable component (element untaxed)
– Tax-free component
|Net rental income from property||$20,000|
|Minimum from $450,000 ABP||$22,500|
For defined benefit income streams, only the amount that is included in ‘taxable income’ will impact the income assessment. From age 60, the tax-free component and the taxable component – element taxed are not included in a client’s taxable income. The only component to include in taxable income is the taxable component – element untaxed ($25,000). If the defined benefit income cap of $100,000 is exceeded, the tax treatment is modified.
We disregard the amount received from Cally’s ABP ($22,500) and use the deeming rates on the value of her ABP ($450,000) to calculate deemed income.
Balance of $398,200
= 0.25% x $51,800|
= 2.25% x $398,200
Accordingly, Cally’s adjusted taxable income for the CSHC includes $25,000 (defined benefit income – taxable component element untaxed), $20,000 rent and $9,089 deemed income from ABP. Her total income is $54,089 and is below the qualifying threshold of $55,808. The combination of low deeming rates and a reduced ABP current balance has allowed Cally to qualify. You recommend that Cally applies to Services Australia for a CSHC.
The prospect of further deeming rate changes
The Government uses its discretion to set deeming rates based on returns available in the market to pensioners for a range of financial investments. The current deeming rates of 0.25% and 2.25% are the lowest since deeming commenced in 1996. Deeming rates were as high as 4% and 6% in 2008 and were still at 3% and 4.5% until early 2013. Accordingly, the variability of deeming rates should be considered as part of your recommendations.
Any future increase in deeming rates could have an adverse effect on clients with a non-grandfathered ABP. In the case study of Blake who commences a new ABP, we should consider the possibility of increased deeming rates in the medium and long term. We know that once grandfathered status is lost, the ABP is deemed from that point. Increased deeming rates will also reduce the allowable level of deemed assets before Centrelink entitlements are reduced under the income test.
The low deeming rates may provide a good opportunity to review clients with grandfathered ABPs. Clients receiving ABP payments significantly exceeding the Centrelink deductible amount could be advantaged by the deeming rules. In these cases, consider commuting and commencing a new ABP. However, if deeming rates increase in the future, the benefits of this strategy would reduce.
Self-funded retirees who have experienced a fall in the current balance of their ABP may wish to consider applying for the CSHC. Reduced ABP balances and low deeming rates are likely to see more clients qualify for CSHC under the income test.
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.