Source: http://ncoa.gov.au/report/appendix-vol-1/9-1-age-pension.html
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﻿ 9.1 The Age Pension
The Age Pension is a fundamental part of Australia’s retirement income system and provides a safety net for those unable to fully support themselves in retirement.
However, changes are required to ensure that the Age Pension remains financially sustainable and well-targeted to those in genuine need. This is especially important in the context of an ageing population and improved life expectancies.
The Age Pension was first introduced in 1909. At the time it was only accessed by a small proportion of the population given the qualification age was 65 and male life expectancy at birth was 55 years.
It supports people who have reached a designated retirement age and are no longer expected to work. The payment has regard to community standards through indexation to wage movements. As such, pensioners share in productivity improvements and rising living standards as their income moves in line with that of people still in the workforce, rather than simply being maintained in real terms over time.
The Age Pension is part of the broader retirement income system. Australia’s retirement income system is often referred to as a ‘three pillar’ system consisting of: basic income support (the Age Pension); compulsory savings (the Superannuation Guarantee); and, support for private savings (such as home ownership and voluntary superannuation contributions).
As the superannuation system matures over the next 20 years, there is expected to be more people who will be able to (at least partly) support themselves. However, there will always be a role for the Age Pension in providing a safety net for those who have been unable to work, were absent from work for extended periods or earned a low income over their lifetime.
The Age Pension age (the age at which a person can access the Age Pension) is currently 65 for men and 64.5 for women (but will soon increase to 65). From 2017 the Age Pension age will be increased by half a year every two years and will reach 67 by 2023.
The Age Pension currently pays a maximum rate of $827.10 per fortnight (around $21,500 per year) for singles and $1,246.80 (around $32,500 per year) for couples combined. For singles, $751.70 of this payment represents the maximum base rate and the remaining $75.40 is paid through various supplements.
The maximum base rate is indexed every six months to the higher of growth in the CPI or the Pensioner and Beneficiary Living Cost Index (PBLCI). The PBLCI is similar to the CPI but adjusted for the basket of goods typically purchased by people on pensions or allowances. The maximum base rate of the pension is then ‘benchmarked’ to Male Total Average Weekly Earnings (MTAWE) – 27.7 per cent for the single rate – which is currently driving the indexation of the payment. The rates of the supplements are indexed to CPI only.
A means test is applied to the rate of pension a person can receive. This includes both an income test and an assets test.
An income test assesses income from employment, business income and income from assets, reducing a person’s payment by 50 cents for every dollar above the income test free area (currently $4,056 per year for singles and $7,176 per year for couples combined).
Other asset classes have no income assessed under the income test. In particular, the principal residence is entirely exempt from the means test (including the income and assets tests). Some other asset classes are also exempt from the income test.
The Age Pension is the largest Commonwealth spending programme, with annual expenditure currently $39.5 billion, growing at 3.7 per cent per year in real terms to 2023‑24. Age Pension expenditure is expected to continue to increase largely as a result of an ageing population, increased life expectancies and benchmarking to MTAWE.
The 2010 Intergenerational Report (Australian Government, 2010a) projected that expenditure on age-related pension payments would increase from around 2.7 per cent to around 3.9 per cent of GDP by 2050.
As part of the three pillar policy, increasing retirement savings through superannuation and other savings will increase self-reliance and reduce dependence on the Age Pension. As shown in Chart 9.1.1, the expected impact of increasing retirement savings is that people will move from being primarily maximum rate Age Pensioners to being part-rate Age Pensioners. It is expected that the proportion of pensioners receiving a part-rate pension payment will increase from 22 per cent in 2008 to 49 per cent in 2049.
Despite the increasing shift towards part-rate pensions the proportion of older Australians eligible for Age Pension is projected to remain constant at 80 per cent. There is no projected increase in the proportion of individuals who are completely self-sufficient despite the significant investment in superannuation over time. This includes the impact of the recent decision to increase the Superannuation Guarantee rate to 12 per cent by 2019-20.
The reasons for this are multi-faceted, but are likely to include people deliberately tailoring their affairs to meet current eligibility criteria such as by consuming assets or transferring equity to the principal residence or other assets that are not means tested. Current means testing arrangements mean that people with significant levels of income or assets can still be eligible for a part-rate pension.
Chart 9.1.1: Projected proportion of eligible persons receiving an Age Pension
The ageing of the population and increasing life expectancies are significant drivers of Age Pension expenditures. Chart 9.1.2 below shows that the proportion of people aged 65 and over is expected to increase from around 13.5 per cent to over 22 per cent by 2050. In particular, the number of people aged over 85 is expected to quadruple. This is expected to result in the number of working age people supporting a person aged over 65 decreasing from around five people today to 2.7 people in 2050.
Chart 9.1.2: Proportion of the population that is 65 or older
Source: Australian Government, 2010a.
As noted in the Productivity Commission report An Ageing Australia: Preparing for the Future (Productivity Commission, 2013), while life expectancy has been increasing there has been little increase in the Age Pension age. Chart 9.1.3 shows that while a person aged 15 born in 1910 could expect to spend around 13 years out of the workforce when they retire, a person today can expect to spend around 30 years out of the workforce.
Chart 9.1.3: Life expectancy at age 15 by average participation
Source: Productivity Commission, 2013.
The indexation of the rate of the pension to MTAWE is also a significant driver of pension expenditure growth. Indexing pensions to MTAWE will increase the real rate of the pension significantly faster than other income support payments at the same time that the ageing of the population increases the population receiving pensions.
The $14.2 billion pension package in 2009 (Australian Government, 2009), which increased the maximum rate of the pension, has also driven recent increases in Age Pension expenditure.
The original rate of the Age Pension was set at £26 per year, or around a quarter of the fair and reasonable wage decided under the Harvester Case, which was an equivalent to the minimum wage at the time.
Since its introduction, the rate of the Age Pension has been increasing on an ad hoc basis through a variety of methods including one-off increases, the addition of new supplements and changes to indexation.
More recently, the Age Pension maximum base rate has been set by linking the rate of payment to wages rather than simply maintaining the payment in real terms. This ensures that pensioners’ standard of living continues to have some reference to the incomes of the broader community.
The base rate of the pension is currently linked to MTAWE. The policy rationale for using this benchmark is weak as the increase in female labour force participation means a wage measure covering only males is an anachronism in the context of contemporary Australia.
Historically, the MTAWE benchmark has been used, as a female or total persons wage index was not published by the Australian Bureau of Statistics until the 1980s.
The total value of the pension has been gradually rising over time, even relative to the benchmark of MTAWE. This is occurring in the context of an ageing population.
Chart 9.1.4 below shows how the maximum Age Pension entitlement has increased relative to wages over time. Historically, the total pension package fluctuated between 20 and 25 per cent of MTAWE until the late 1980s. In the 1990s and mid-2000s the total pension package was worth around 25 to 27 per cent of MTAWE, or around 30 per cent of AWE.
Chart 9.1.5 shows that the real value of the pension has increased significantly over time. During the 1970s through to the 1980s, the value of the Age Pension was around $500 per fortnight in today’s dollars. In the mid 2000s, the value of the Age Pension reached $600 per fortnight in today’s dollars. Today, the real value of the pension is around a third higher than it was in the early 2000s at $827.10 per fortnight. This value will continue to increase in real terms under current indexation rules.
Chart 9.1.4: Maximum fortnightly single rate of the Age Pension as a proportion of wages
Source: National Commission of Audit; ABS, 2013b; DSS, 2013.
Note: The above chart includes supplements to the pension such as the Pension Supplement.
Chart 9.1.5: Maximum fortnightly single rate of the Age Pension in real terms
Source: National Commission of Audit; ABS, 2013a; DSS, 2013.
The Commission considers that Average Weekly Earnings (AWE) is a more appropriate benchmark for the rate of the pension. It is more appropriate than MTAWE given that women are a major part of the labour force and it more closely represents the wage received by the average worker. Benchmarking to AWE still recognises that pensions should have regard to community standards through benchmarking to wages and is a more generous measure than the median wage (the mid-point wage).
The Commission recommends that the Age Pension rate transition over time to be equal to – and then grow in line with – 28 per cent of AWE. The re-alignment over time could be achieved by indexing the current maximum base rate of the Age Pension to the higher of CPI or the PBLCI until it reaches the new benchmark. As shown in Chart 9.1.6 below, on current trends the transition can be expected to be completed by around 2027-28.
Chart 9.1.6: Current and proposed maximum base rate of the Age Pension, single persons
Importantly, under these transitional arrangements, the value of the Age Pension will be maintained in both real and nominal terms until the new benchmark is reached. Upon reaching the new benchmark, the maximum base rate of the Age Pension will resume growing in line with growth in AWE, rather than MTAWE. Post transition, indexation should also maintain existing price indexation arrangements. That is, the Age Pension should increase in line with the higher of AWE or CPI/PBLCI.
Consistent with the approach outlined above any changes to eligibility should only affect new recipients and even then there should be a reasonably long lead time recognising that people need sufficient notice given the importance of decisions that are often taken ahead of retirement. No existing recipient of the Age Pension will have their eligibility and pension amount reduced as a consequence of any of the Commission’s recommendations in this area.
The Age Pension age is currently scheduled to increase to 67 by 2023. There is a strong case to build on this existing process and link the Age Pension age to improvements in life expectancy.
The Age Pension age has remained largely unchanged since its introduction in 1909. However, people are now spending a higher proportion of their lives in retirement.
Not only are people now experiencing longer retirements, but changes in the nature of work and improvements to medical technology have meant that many people (but not necessarily all) are also experiencing healthier and more active retirements.
With people experiencing longer and healthier retirements, it is appropriate to increase the Age Pension age.
As shown below, it is proposed that after the current scheduled increase in eligibility age to 67 in 2023, the Age Pension age be indexed to a proportion of average life expectancy for all persons at age 65.
Life expectancy at age 65 represents a good estimate of how long someone approaching retirement can expect to live. In addition, this measure means that improvements in infant mortality will not drive rises in the Age Pension age in the future.
It is considered that a period measure of life expectancy such as this is a better basis for the indexation of the Age Pension age compared to a cohort measure of life expectancy. Period measures of life expectancy are based on current observed mortality rates whereas cohort measures project future increases in mortality which are uncertain.
A proportion of life expectancy can be decided on that will achieve a steady increase in the Age Pension age, such as increasing by around half a year every five years. The Commission considers that people born before 1965 (who are currently around 50) should not be affected to give adequate time to plan for the change. The Commission estimates that setting the Age Pension age at 77 per cent of life expectancy at 65 would achieve this outcome and would see the Age Pension age reach 70 years by 2053.
Chart 9.1.7: Current and recommended increase to the Age Pension age
Source: National Commission of Audit based on Treasury data.
The Age Pension age could be set every five years and rounded to the nearest half year of age. See Chart 9.1.7 and Table 9.1.1 for the proposed and current schedules.
Table 9.1.1: Age Pension age and life expectancy
Proposed Age Pension age
a percentage of life expectancy at 65
Source: National Commission of Audit calculations based on Treasury data.
The current system of means testing for the Age Pension is complex and inequitable. Various asset classes are assessed differently under either the income test or the assets test. As a result, people with the same means may have different pension entitlements.
In implementing any changes to the pension means test, the Commission gives weight to the idea of a no disadvantage test being applied to current recipients. The new rules could apply to people born from 1960 in recognition that significant financial decisions are made by people close to retirement. The group affected is currently aged in their mid‑50s and could be expected to reach Age Pension age by 2027.
Consistent with the recommendation from the Australia’s Future Tax System (Henry) Review, the Commission recommends replacing the current income and assets tests with a single comprehensive means test based on a comprehensive measure of income. This comprehensive means test would combine income earned from sources such as employment with income deemed from assets. This is shown in Chart 9.1.8 below.
Chart 9.1.8: A comprehensive means test
Source: Adapted from Australian Government, 2010b.
Deeming arrangements should apply to all asset classes and the assets test would be abolished. The deeming rates could be based on the returns expected from a portfolio of assets held by a prudent investor.
Extending deeming will change the means testing arrangements for many assets, including investment properties, holiday homes and the principal residence.
The assets test should be removed as it assesses means on a less comprehensive basis. This has the benefit of encouraging self-provision for retirement and reducing the overall complexity of the means test. An assets test is only necessary when income from assets is not assessed on a comprehensive basis.
The principal residence is currently exempt under the means test. This is inequitable as it allows for high levels of wealth to be sheltered from means testing. Under current arrangements someone can transfer their savings in superannuation or other sources to upgrade their home or pay off the mortgage and simultaneously increase their pension entitlement.
For example, under current rules a single person who owns a $400,000 house and has $750,000 in shares ($1.15 million in total assets) would not be eligible for the pension, while a similar person with a principal residence worth $2 million and $100,000 in shares ($2.1 million in total assets) would be able to claim a pension at the full rate.
The Productivity Commission has noted that many older households have saved for retirement through building equity in their own home (Productivity Commission, 2013). They found over 80 per cent of older households own their own home but retirees typically do not use this equity. Chart 9.1.9 shows that older households have the highest levels of equity in their homes but the lowest disposable incomes for all age groups. In other words, retirees tend to be income poor but asset rich.
Chart 9.1.9: Disposable household income and principal residence value by age, 2009-10
The value of the principal residence should be included in the comprehensive means test above a certain threshold. This threshold should be $750,000 for couples noting that this could be expected to affect around 10 per cent of coupled Age Pensioners based on 2011-12 data. Using a two-thirds relativity, the threshold for single pensioners could be set at $500,000 which is estimated to affect around 25 per cent of single Age Pensioners based on 2011-12 data (ABS, 2012). The threshold in 2027-28 would be equivalent to the indexed value of a residence valued today at $750,000 for coupled pensioners and the indexed value of a residence valued today at $500,000 for a single pensioner.
Including the principal residence in the means test will not force pensioners to move out of their homes. Financial products – such as reverse mortgages or home reversion products – exist which allow homeowners to draw down on the value of their home over a period of time. Importantly, these products have legal protections ensuring that no-one can be forced from their homes, even in the event that all equity has been exhausted.
The Productivity Commission has recognised the potential for older Australians to access the equity in their homes to pay for the costs associated with ageing.
Policy measures that overcome the barriers that individuals and households face in accessing the equity in the home may play a future role in freeing up resources for greater contributions to age-related expenses such as health and aged care, without affecting older people’s other consumption (Productivity Commission, 2013).
In the inquiry into the aged care system, the Productivity Commission also recommended that a government-backed scheme would allow older Australians to pay for their aged care costs using equity in their home (Productivity Commission, 2011).
The Commonwealth has recognised that consumers are unfamiliar with these types of products. In response, changes to regulations around reverse mortgage products were announced in 2011 which provided increased protection for consumers through a ‘no negative equity’ guarantee and improved the information given to consumers by providers.
Current income test parameters, including the taper (or withdrawal) rate and income free area, can mean that people with significant means can access a part pension. As shown in Chart 9.1.10 below, someone with $47,000 in annual income may still be eligible for some pension under the current income test. The current income test withdraws the pension at a rate of 50 cents for each dollar of income above the income test free threshold which is currently $156 per fortnight for a single person.
Chart 9.1.10: Age Pension entitlement, current and recommended income test
Note: The rate of the Age Pension is as at 20 September 2013.
Increasing the pension income test withdrawal rate would remove access to the payment or reduce the rate of payment for many pensioners with significant private income. This would reduce the number of people with significant means accessing the pension.
In balancing the need to target pensions to those most in need of assistance with the goal of providing incentives for self-provision, the Commission recommends that the income test withdrawal rate for pensions be increased to 75 per cent.
A withdrawal rate of 75 per cent would bring the pension cut-out point in line with other parameters of Australia’s social safety net system. For example, the new cut-out point would be similar to the minimum wage. In addition, the new cut-out point would be similar to the point where a single senior Australian begins to pay personal income tax.
It is a feature of the social security system that the Age Pension income test is linked to the income test for other pensions including the Disability Support Pension, Service Pension, Carer Payment and other pensions.
Recommendations relating to the changes in the Age Pension benchmark will flow through to these pensions. In particular, transitioning the pensions to the new benchmark of 28 per cent of Average Weekly Earnings should apply at the same time as implementation of those changes to the Age Pension benchmark.
Implementation of Age Pension recommendations
The proposed changes to the Age Pension (including with flow-on to other income support payments) will lead to significant reform and put Age Pension expenditure on a sustainable path.
The Commission recognises that significant decisions are made in the lead up to retirement and that ample warning needs to be given to future retirees for significant changes. As shown in Chart 9.1.11, recommendations contained in this chapter have been phased in to avoid significant impacts for those in or near retirement.
The recommended re-benchmarking of the Age Pension would not diminish the real value of a person’s pension entitlement. Payments will still grow at CPI or PBLCI, meaning they can expect to be able to continue to purchase the same basket of goods and services they do today.
Recommendations relating to changes to means testing and the Age Pension age will only affect new entrants. In addition, there will be significant lead times to allow future retirees to adjust to the new means test and Age Pension age. Those affected by the changes to the means test will be in their mid 50s today, while no-one born before 1965 would be affected by recommended changes to the Age Pension age.
Chart 9.1.11: Potential phasing of Age Pension reform
Note: * The end of the phase-in period for the new benchmark is a projection and will depend on growth in prices and wages.
The Superannuation preservation age
In regard to reform of the broader retirement income system, any longer term consideration of superannuation tax concessions would be best considered in the context of the Government’s White Paper on Tax Reform. The Commission notes that many superannuation tax concessions disproportionately benefit higher income earners, when compared to taxation at marginal tax rates under the progressive income tax system.
The Commission has recommended that changes be made to link the Age Pension eligibility age to changes in the life expectancy rates of Australians. Should the Government take up this option, the Commission would recommend that the existing superannuation preservation age also be increased.
As shown in Chart 9.1.12 and Table 9.1.2, the gap between when people can access their superannuation (preservation age) and Age Pension age will shrink over time from 10 to seven years. This is because the current increase in the preservation age to age 60 is phasing in at a faster rate than the Age Pension age increase. This gap will widen again from 2033 if the Commission’s recommended changes to the Age Pension age are adopted.
Chart 9.1.12: Current and recommended preservation age schedules
Table 9.1.2: Superannuation preservation age
Proposed Superannuation Preservation Age
Gap Between Preservation and Age Pension Age
There have been suggestions the preservation age and Age Pension age be aligned over time, including from the Henry Tax Review (Australian Government, 2010b) and the Grattan Institute (Daley J, McGannon C, Savage J and Hunter A 2013). The Commission recognises that increasing the preservation age involves a trade‑off between restricting retirees’ access to their own savings and improving fiscal sustainability and workforce participation.
It is proposed that the preservation age be increased further to establish and maintain a gap of five years between it and the Age Pension eligibility age. This should be maintained into the future, including if the Age Pension age should increase further.
The Commonwealth Seniors Health Card provides cash benefits and a range of concessions to Australians above Age Pension age who do not access a pension. To be eligible, seniors must also have Adjusted Taxable Incomes below $50,000 for a single person and $80,000 combined for couples. Approximately 300,000 people currently hold a Commonwealth Seniors Health Card.
Holders of the Commonwealth Seniors Health Card receive a Seniors Supplement of $858 each year for singles and $647 each year for members of a couple. Holders also receive a Clean Energy Supplement of $356 each year for singles and $265 each year for members of a couple.
There are also a range of concessions including: access to discounts on Pharmaceutical Benefits Scheme prescription medicines; a lower Medicare Safety Net; and concessional rail travel on Great Southern Rail services. State and local governments and private companies may offer additional concessions to Commonwealth Seniors Health Card holders.
The Commission recommends that the Commonwealth Seniors Health Card be maintained as part of Australia’s retirement income system, but that changes be made to improve targeting to those most in need by adding deemed income from tax-free superannuation to the definition of Adjusted Taxable Income used for determining eligibility for the Commonwealth Seniors Health Card.
Australian Bureau of Statistics (ABS) 2012, Survey of Income and Housing, Australia, cat. no. 6541, ABS, Canberra.
Australian Bureau of Statistics 2013a, Consumer Price Index, Australia, cat. no. 6401.0, ABS, Canberra.
Australian Bureau of Statistics 2013b, Average Weekly Earnings, Australia, cat. no. 6302.0, ABS, Canberra.
Australian Government 2009, Pension Review Report, Australian Government, Canberra.
Australian Government 2010a, Intergenerational Report 2010, Australian Government, Canberra.
Australian Government 2010b, Australia’s Future Tax System Review, (Henry Tax Review), Australian Government, Canberra.
Daley, J McGannon, C, Savage, J and Hunter, A 2013, Balancing Budgets: Tough Choices We Need, Grattan Institute, Melbourne.
Department of Human Services 2013, A Guide to Australian Government Payments, 1 January – 19 March 2014, Centrelink, Canberra.
Department of Social Services (DSS) 2013, Guides to Social Policy Law, viewed January 2014, <http://guidesacts.fahcsia.gov.au/guides_acts/homeint.html>.
Productivity Commission 2011, Caring for Older Australians, Research Report, Canberra.
Productivity Commission 2013, An Ageing Australia: Preparing for the Future, Research Report, Canberra.
Rothman 2012, Modelling the Sustainability of Australia’s Retirement Income System, Paper presented to the 20th Annual Colloquium of Superannuation Researchers July 2012, University of New South Wales, Sydney.
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