The Age Pension provides basic income support for those Australians who are above retirement age but are not able to fully support themselves with their own means.
The Age Pension was introduced in 1909 and was accessed by a small proportion of the population given the qualification age was 65 and male life expectancy at birth was 55.
In 2009, the Commonwealth implemented the recommendations of the Harmer Pension Review, which increased the benchmark for the singles rate of the Age Pension from 25 per cent to 27.7 per cent of Male Total Average Weekly Earnings, and scheduled the age of access to the pension to rise from 65 to reach 67 by 2023.
In 2013-14, an estimated $39.5 billion will be spent on the Age Pension, benefitting 2.4 million recipients. Expenditure on the Age Pension is currently growing at 7 per cent per year. Age Pension expenditure is expected to continue to increase largely as a result of an ageing population, increased life expectancies and benchmarking to the Male Total Average Weekly Earnings benchmark.
The features of the Age Pension means test, such as a 50 per cent taper rate and high income free area, can mean pensioners with relatively high levels of income (up to $47,000 in annual income) are able to access a part-rate pension.
As shown in Chart 7.1 on current projections there is unlikely to be an increase in the proportion of individuals who are completely self-sufficient and not reliant on the Age Pension despite the significant investment in superannuation over time. Even allowing for a decline in the proportion of people receiving the full pension, a rise in the number of people receiving the part-rate pension will see the proportion of older Australians eligible for the Age Pension remaining constant at 80 per cent over the next forty years or so.
In the Commission’s view the Age Pension should be regarded primarily as a social safety net, with the objective of providing security for older Australians who are unable to support themselves in their retirement. Older Australians with the resources to fund their own retirement should do so.
The Commission considers that changes are needed to ensure that the cost of the Age Pension remains sustainable and affordable and well targeted to those in genuine need.
Many Australians make significant decisions in the lead up to their retirement and it is essential that ample warning be provided to future retirees of any significant changes to Age Pension arrangements. The approach should be to phase in implementation of major changes to avoid significant impacts for those in retirement or those nearing retirement.
The Age Pension Benchmark
Historically, Age Pension rates have been set with regard to community standards through linking the rate of payment to wages rather than simply maintaining the payment in real terms. This ensures that a pensioner’s standard of living continues to have some reference to the incomes of the broader community.
The Age Pension has increased over time, not just in real terms but also relative to wages earned by those in paid employment. This is occurring in the context of an ageing population.
A summary of changes in the real value of the Age Pension over time is outlined in Section 9.1 of the detailed Appendix to this report.
The rate of the pension is currently linked to Male Total Average Weekly Earnings. 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.
Average Weekly Earnings is a more appropriate benchmark for the rate of the pension, given that women are a major part of the labour force. Benchmarking to Average Weekly Earnings still recognises that pensions should have regard to community standards through benchmarking to wages.
It is proposed that the maximum base rate of the Age Pension be changed over time to be equal to, and then grow in line with, 28 per cent of Average Weekly Earnings.
The re-alignment over time could be achieved by indexing the current maximum base rate of the Age Pension to the higher of the growth in the CPI or the Pensioner and Beneficiary Living Cost Index until it reaches the new benchmark.
As shown in Chart 7.2 below, on current trends the transition can be expected to be completed by around 2027-28 (that is in just under 15 years time).
The recommended re-benchmarking of the Age Pension will ensure that Australia’s Age Pension programme is more sustainable over the long-term. The proposed transition to the new arrangements will ensure that a person’s pension entitlement does not fall in either real or nominal terms.
Recommendation 12: Age Pension – establishing a new benchmark
The Age Pension is an essential part of Australia's social safety net. The Commission recommends that changes be made to make it more sustainable by:
- changing current Age Pension indexation arrangements to a new benchmark of 28 per cent of Average Weekly Earnings and maintaining other price indexation arrangements; and
- transitioning to this arrangement, approximately over a 15 year period, by indexing the Age Pension maximum base rate at a rate equal to the higher of the growth in the Consumer Price Index or the Pensioner and Beneficiary Living Cost Index until it is equal to 28 per cent of Average Weekly Earnings.
Eligibility for the Age Pension
As well as suggesting changes to the benchmark arrangements for the Age Pension, the Commission considers that there is a strong case to re-examine other aspects of Australia’s Age Pension system including tightening eligibility requirements to improve its targeting to those unable to support themselves in retirement.
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 or pension amount reduced as a consequence of any of the Commission’s recommendations in this area.
The potential changes to the Age Pension arrangements outlined below, if agreed by government, would need to be introduced over a significant period of time.
These changes include further adjustments to the Age Pension eligibility age as well as a simplification and strengthening of the Age Pension means test.
The Age Pension eligibility age is currently scheduled to increase to 67 by 2023.
There is a strong case to build on this existing process and establish a formal link between the Age Pension age and improvements in life expectancy. (Further details are outlined in Section 9.1 of the Appendix).
Not only are people now experiencing longer retirements, but changes in the nature of work and improvements to medical technology have meant that many (though not necessarily all) people are also experiencing healthier and more active retirements.
As shown in Table 7.1 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.
The proportion used should achieve a steady increase in the Age Pension age, such as increasing by around half a year every five years. 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.
The Commission considers that people born before 1965 should not be subjected to this change or any other further changes to the eligibility age to ensure they have adequate time to plan for their retirement.
Age Pension age as
Source: National Commission of Audit.
Note: The Age Pension age is already increasing under current policy from 65 to 67 by 2023.
The Age Pension could also be better targeted by introducing a simpler single comprehensive means test.
The move to a comprehensive means test could apply from 2027-28, to new recipients of the Age Pension, to allow people sufficient time to adjust to the new arrangements.
A new single comprehensive means test could replace the current arrangement which is underpinned by dual income and assets tests. The existing assets test could be abolished and the income test extended by deeming income from a greater range of assets.
The deeming rates could be based on the returns expected from a portfolio of assets held by a prudent investor. Under this proposal, there would be a single income test based on a combined measure of employment income, business income and deemed income on assets.
Extending deeming could change the means testing arrangements for many assets, including investment properties, holiday homes and the principal residence. The removal of the assets test aims to encourage saving and reduce the complexity from having two tests.
Many older households have saved for their retirement through building equity in their own home. Retirees tend to be income poor but asset rich.
The principal residence is currently exempt under the means test. This allows for high levels of wealth to be sheltered from means testing. The Commission considers that a proportion of the value of the principal residence should be included in the means test, such as the value over a relatively high threshold. The means test would capture the value above $500,000 for single pensioners and $750,000 combined for coupled pensioners.
Exempting the principal residence from the means test is inequitable as it allows for high levels of wealth to be sheltered from means testing. 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.
Financial 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. A high threshold will mean that there is significant equity that would not be assessed.
With any changes recommended to apply from 2027-28 onwards and only to new recipients of the Age Pension, no current pensioner would be affected by this change. That is, no existing recipient of the Age Pension would have their eligibility or pension amount reduced by the proposed inclusion of the principal residence in the Age Pension means test.
As well as moving to a comprehensive income test, the Commission believes there would be merit in re-examining other aspects of the means testing arrangements.
Current income test parameters can mean that someone with $47,000 in annual income may still be eligible for some pension under the current income test. Increasing the pension income test withdrawal rate (currently 50 per cent) would reduce the number of people who have significant means from 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. This would mean that a single pensioner with private income of around $32,700 would no longer receive the pension.
Again, in implementing the comprehensive means test and an increase in the withdrawal rate, it is proposed that a no disadvantage test be applied to current recipients. The new rules would 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 would be expected to reach Age Pension age in 2027.
Recommendation 13: Age Pension – tighter targeting of eligibility
The Age Pension is an essential part of Australia's social safety net. The Commission recommends that changes be made in future to ensure it is more sustainable, affordable and better targeted by:
- formally linking the eligibility age of the Age Pension to 77 per cent of life expectancy at age 65 from 2033. This will result in the eligibility age for the Age Pension increasing to around 70 by 2053. The proposed change would not affect anyone born before 1965;
- replacing the current income and assets tests with a single comprehensive means test. Under this approach the existing assets test would be abolished with the income test extended by deeming income from a greater range of assets. The new comprehensive means test would apply prospectively to new recipients of the Age Pension from 2027-28 onwards;
- including in the new means test the value of the principal residence above a relatively high threshold. 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. This change would apply prospectively to new recipients of the Age Pension from 2027-28 onwards; and
- increasing the income test withdrawal (taper) rate from 50 per cent to 75 per cent. This change would apply prospectively to new recipients of the Age Pension from 2027-28 onwards.
Chart 7.3 below provides an indication of how the recommended reforms to the Age Pension could be introduced over time.
Source: National Commission of Audit.
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 Age Pension and superannuation are interrelated elements of the retirement income system and should be considered in parallel when changes to one or the other are proposed.
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 should also be increased.
As shown in Chart 7.4 below, 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 at a faster rate than the Age Pension age increase. This gap would widen again from 2033 if the Commission’s recommended changes to the Age Pension age are adopted.
It is proposed that the preservation age be increased further to establish and maintain a gap of 5 years between it and the Age Pension eligibility age. This gap should be maintained into the future, including if the Age Pension age should increase further.
Recommendation 14: Superannuation preservation age
The Age Pension and superannuation are interrelated elements of the retirement income system. The Commission recommends some changes be made to the superannuation system to complement changes being recommended for the Age Pension by:
- increasing the superannuation preservation age to five years below the Age Pension age;
- extending the current phased increase in the preservation age by an extra four years so the preservation age reaches 62 by 2027; and
- increasing the preservation age in conjunction with the Commission's proposed increases in the Age Pension age thereafter.
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. Benefits can include the Seniors Supplement, the Clean Energy Supplement and concessional Pharmaceutical Benefits Scheme medicines. State and local governments and private business may also offer additional concessions.
To be eligible, seniors must also have Adjusted Taxable Incomes below $50,000 for a single person and $80,000 combined for couples. Income from tax-free superannuation is not included in the means test.
Approximately 300,000 people currently hold a Commonwealth Seniors Health Card.
The Commonwealth Seniors Health Card could be better targeted to those most in need.
The definition of income used for the Commonwealth Seniors Health Card is Adjusted Taxable Income. This definition of income is a broad measure of means based on taxable income but adds in other means such as fringe benefits.
As the income from tax-free superannuation is not included in Adjusted Taxable Income, the definition of income for the Commonwealth Seniors Health Card omits a major income source of retirees. This can result in inequities as retirees with very large superannuation balances can access government support, leading to differential treatment for people with the same means.
For example, a senior has $2 million in term deposits and as a result is not eligible for an Age Pension. They earn a return of 4 per cent each year, meaning their Adjusted Taxable Income is $80,000 and are not eligible for a Commonwealth Seniors Health Card. Alternatively, a person earning the same return but with $2 million invested in superannuation and $1 million in term deposits would have an Adjusted Taxable Income of $40,000 and would therefore be eligible for a Commonwealth Seniors Health Card.
Recommendation 15: The Commonwealth Seniors Health Card
The Commonwealth Seniors Health Card gives senior Australians who do not receive a pension, access to cash payments and concessions and discounts on certain products.
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.