Can too much superannuation cost you?

Sometimes government payments can produce some perverse incentives, such as payments that might be high enough to cause people to delay returning to work.

One of the more poorly understood examples of a perverse outcome which is set to become really important over time is the current interplay between superannuation savings and the aged pension.

It is reasonably well known that to qualify for the pension you need to satisfy an assets and income test.

At the moment for a single pension of $1096.70 a fortnight you can earn $204 a fortnight from super, with the pension reducing by 50c for every extra dollar from super.

On the assets test a homeowning single person can have up to $301,750 in assessable assets, with the pension reduced before cutting out when assets reach $667,500.

The figures are higher for couples and also for non-homeowners and it is also possible to earn some personal exertion income on top of super payments while on the pension.

Interplay between pension and super produces perverse results

What is perhaps not as well understood is how these tests interplay with superannuation.

In very broad terms, what happens to a couple is that the pension starts to be reduced once their combined super accounts hit around $800,000 and cut out entirely when their super is $1.2 million.

These are rough numbers only and the exact position can only be worked out given individual circumstances for income and assets but they are close enough for our purposes here.

What is really worth noting here though is that the progressive reduction of the age pension is generally greater than the benefit of the extra super, so that the fortnightly “cash in hand” difference between a couple with $800,000 in super and $1.2 million is negligible and sometimes even negative for the “richer” couple.

That somewhat perverse outcome comes about because the returns on the “extra” super money are unlikely to be greater than the income forgone by phasing down and out of the age pension.

Trying too hard to qualify for a pension can be a mistake

There are a few things to note here.

One is that while the amount of $800,000 in super might seem like a lot to many people, it will become increasingly common as the super system continues to mature with people having spent more time in work with a larger portion of their income being paid into super and compounding over time.

Secondly, while in income terms the couple with a combined $1.2 million in super might not be as “well off” in income terms as those with much less in super getting the full pension, they still enjoy a lot more financial flexibility because they can withdraw large amounts of capital tax free at any time.

And finally, it can be a really big mistake to be too fixated on being paid the age pension or qualifying for a part pension.

Is the pension a must have or a safety net?

So, what should a couple do if they think they might end up with a combined super of $800,000 or more, or an individual who might end up with $400,000 or more?

Does it mean they should try to restrict their super because they want to qualify for a full or partial pension?

Or should they continue to put as much as possible into super even if that gets them closer to the strange middle ground in which they might actually lower their income?

I think the answer lies in how people think about the pension, with the modern idea really being that it is more of a very valuable safety net if things go wrong or super balances fall over time rather than a necessity of life that must be claimed no matter what.

The really great thing about the age pension is that it is always there should things go wrong with a few bad years in a row on investment markets or if significant health or accommodation costs arise that greatly reduce super balances.

Using the pension safety net to take on more risk

With this new mindset, it is possible to be aspirational about super and perhaps take on a little more investment risk than would otherwise seem prudent.

After all, the entire design of superannuation was to reduce dependence on the age pension and to ensure the pension system remained sustainable in the long term.

That is largely happening before our eyes, with the result that people who amass around $2 million per couple in super are unlikely to ever go on the pension, while some of those couples in the land of perverse incentives – the $800,000 to $1.2 million range – might initiate or go on to a part or even full pension depending on their longevity or spending patterns.

Those with much lower and more common super balances below these approximate numbers will be able to qualify for a full pension right from the start, with their super amounts still providing a very important buffer for spending lump sums on lifestyle or essential purchases, particularly in the early and generally more active years of retirement.

In that respect, it is always important to maximise super lump sums to allow for as much financial flexibility as possible, without focussing too much on qualifying for the pension and the associated fringe benefits.

It is also reassuring that those age pension income “safety net” benefits should always be there as lump sums diminish over time and it is certainly worth having the numbers in mind and checking to see when part pension eligibility is approaching.