Q&A – The impacts of a charge or encumbrance on assets

Find out what your peers are asking – based on real-life questions submitted to TechConnect.

By Julie Steed, Senior Technical Services Manager

Q: My clients own their family home worth $700,000, where they have lived for 30 years.

They own an investment property worth $600,000 which has a loan for $ 480,000. Their family home is also used as security on the investment property loan. Net rental income is $10,000 pa.

My clients have cash and shares investments of $400,000, and car and contents worth $10,000.

They make their Centrelink application believing that they have assessable assets of $530,000 (being $120,000 equity in the investment property, $400,000 cash/shares investments and $10,000 of car and contents).

Based on our rough calculations we expect that they will receive a fortnightly payment of $541.80 each ($14,086 pa). 

Why are Centrelink only paying a pension of approximately $154.80 each per fortnight?

A: Under Social Security law, if a charge or encumbrance is secured against both an exempt asset and an assessable asset, the amount of the outstanding charge or encumbrance is shared between the assets in proportion to the asset values1

The formula for calculating the asset deduction amount is:

Value of the charge or encumbrance   x   value of the assessable assets
value of all assets secured against the loan

For your clients, the value of the debt that reduces the value of the investment property is:

 $480,000  x  $600,000 $221,538
   ($600,000  +  $700,000)                        

The asset value of the investment property is therefore defined as $378,460. 

Your client’s Centrelink application will be assessed on the basis that they that have assessable assets of $788,460 (being $378,460 equity in the investment property, $400,000 cash investments and $10,000 of car and contents).

On this basis, they receive a fortnightly payment of $154.80 each ($4,024 pa).

The $387 reduction in their fortnightly payment each could have been avoided if they had managed to have their family home removed as security for the investment property loan.

1 Social Security Act 1991 subsection 1121(4)

More information

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.