Wouldn’t it be great if we lived in a world where you could make a risky investment (shares would be the prime candidate) and if the market value went down, there was someone who would say:
“Gee, we’re really sorry that it didn’t work out so well for you. To make you feel a bit happier about it, we will give you some money. We will give you more income than you could have hoped to have received from your “lost” capital if the market had not fallen. We will do that for as long as it takes until your investment recovers. And you still get to keep all the income you actually receive from your investment. And best of all, we are giving you this investment insurance FREE!”
Wow, how generous would that person be?
Amazing? Too good to be true?
But here’s the thing. If you are a part pensioner and the amount of age pension you receive is limited by the assets test rather than the income test, you are living in that amazing world, here and now! Yippee!!! Wahoo!!! Party, party, party!!!
And who is your generous benefactor? The Australian government, that’s who. I hope you sent a Christmas card to the Treasurer last year. He should be very high on your Christmas card list.
Only it’s not called “free investment insurance”. It’s called the assets test. This is how it works.
Case Study: Vincent and Wendy.
Let’s assume that Vincent and his wife Wendy:
- are both of pension age and are eligible for the pension
- own their own home
- have no earned income from employment or any source other than from their investments
- have financial assets of $600,000 for the purpose of the assets test and
- historically they have invested the $600,000 in bank deposits earning 2% but now they have decided to invest the whole amount in shares.
Their switch from 100% cash to 100% shares is a very dramatic change in their asset allocation. Such a dramatic change would probably not be recommended by many financial advisers. But this case study is a hypothetical one to illustrate a point.
According to the Department of Human Services website, the lower asset test threshold for a homeowning couple since 20 September 2017 has been $380,500 and the upper threshold has been $830,000. So now that Vincent and Wendy have invested the $600,000 in shares, rises or falls in the value of their portfolio will affect their age pension. For every $1,000 decrease in the market value of their assets, their combined pension will increase by $3.00 per fortnight. That amounts to a total of $78 per year.
In other words, if the market value of their investments falls, the government will give them an additional pension equal to 7.8% per annum of the amount of the fall in the market value of their investment assets. What is more, they still get to keep all of the income from their investment. The actual amount of income from their investment doesn’t feature anywhere in the assets test or the income test because their income from financial assets is “deemed” for the purpose of the income test. Centrelink assumes that they earn a particular amount based on the market value of your assets.
So let’s imagine that there is a 25% market “crash”. So the value of their share portfolio falls from $600,000 to $450,000. Disaster, apparently. But what happens to Vincent and Wendy’s income?
Before the crash they received dividends of (say) 4% of their portfolio of $600,000 or $24,000 plus an age pension amount of $8,969 per pensioner. (The age pension amounts are estimated using the yourpension.com.au website, assuming that they have no other assets.) So their total income of $41,938. After the crash, they may still receive most or all of their $24,000 dividends because often a “crash” occurs not because dividends fall but because of market sentiment. But for the sake of the argument, let’s say that their dividends do indeed fall by one sixth to $20,000. But their pension entitlement now is $14,819 each for total income of $49,638. In other words they are 18% ($7,700) better off after the crash than before it! Even if their dividends fell by 25% in the crash (which would be unusual) their post-crash income would be $47,638. That would still more than 13% better than before.
So in income terms, Vincent and Wendy will be markedly better off after the “crash” than they were before. This occurs even though the market amount of their assets will have fallen. But share markets are volatile and move up and down from time to time, so it is possible that post-crash they will recover their pre-crash value. In that case their total asset value will revert to the previous $600,000 figure. But they will have received a lot of additional pension in the meantime!
There is a flip side to the “free investment insurance”. If the market value of Vincent’s and Wendy’s shares increases, then the assets test operates in reverse. Their age pension amount will decrease. But Vincent and Wendy could mitigate this impact if they wished by spending some or all of the asset value increase on lifestyle expenses. Maybe they will take a trip to Europ. Or renovate their house – and install the new kitchen and bathroom that Wendy has been wanting to do for years.
Let’s summarise what happens to Vincent and Wendy according to what happens to their share investments.
If the market goes up, they take a trip to Europe and renovate the house. After that, they have the same level of assets and the same total income as they had before.
If the market goes down, they can’t afford the Europe trip or the renovation. But at least they get a lot more income than they had before (at least until the market recovers).
If the market is flat, their $600,000 investment holds its value and they get $24,000 in dividends from their shares. That’s a lot better than the $12,000 they would have got by leaving the money in the bank.
So the impact of the Treasurer’s free investment insurance may induce some part pensioners to invest in risky assets. (Actually, Mr Morrison didn’t invent the free investment insurance, but he did double its value on 1 January 2017. That’s when the “taper rate” implicit in the assets test increased from 3.9% to 7.8%.)
So, if you are a part pensioner and your pension is governed by the assets test rather than the income test, and you choose to invest in volatile assets, be grateful for the free insurance that the government provides.
And don’t forget to add the Treasurer to your Christmas card list.