Budget 2009-10 - Pension Review Report

7. Sustainability and targeting

Overview and findings

This chapter considers the sustainability and targeting of the pension system.

It was not possible for the Review to develop considered views on its terms of reference without taking into account the sustainability of the reform directions it has identified. This required the Review to consider whether the current targeting of income support payments will continue to be effective in the short, medium and longer term.
As noted in Chapter 3, there is also a need to consider the appropriateness of the levels of pension payments for those with low to moderate reliance on income support. The analysis and discussion in Chapter 3 was concerned with the appropriate level of the rate of payment of the pension to those who are wholly reliant on it, and made no assumptions about access to private means.

This chapter outlines how the pension means test operates, and discusses the issues that need to be considered in seeking to achieve a fair and sustainable balance in the pension system, in particular between effective targeting of assistance and incentives for people to participate in the labour market and support themselves.

The chapter analyses the current impact of means testing on the appropriateness of the levels of pension received by those with private means, the relationship between the two principal elements of the means test (the income and assets tests), and the effectiveness of the current definitions of income and assets used in the means test, including the treatment of earned income and income from superannuation.

In the context of demographic change, including strong gains in life expectancy and the importance of workforce participation, the chapter considers the focus and eligibility criteria for pensions, including the Age Pension age.

The Review’s findings in this chapter are presented in two groups:

the efficiency and effectiveness of the pension means test
the eligibility criteria for pensions, including the question of the appropriateness of the current Age Pension age.

In relation to the efficiency and effectiveness of the pension means test, the Review has made a number of findings concerning the impact of the means test on the level of support for pensioners with private means, incentives to take up paid work, and the treatment of account-based superannuation products.

The Review’s findings on these aspects of the means test reflect two objectives. The Review considers that there would be merit in targeting any increase in payments designed to support pensioners who are wholly reliant on the pension. There is no evidence that the means test is operating to leave pensioners who have a low to moderate level of reliance on the pension with inadequate total income.

Finding 25: The Review finds that there is no evidence that the means test as a whole is operating to provide an inadequate level of support to pensioners with low to moderate reliance on the pension.

Finding 26: The Review finds that, in the case of an increase in the pension rate to achieve an improvement in adequacy and financial security for those pensioners for whom the pension is the predominant source of income, there would be capacity to tighten income test settings to limit the flow-on of the increase to pensioners with low to moderate reliance on the pension. (Section 7.5.1)

The second objective was to improve the efficiency of the means test through responses to increase incentives for workforce participation and to redress anomalies in the treatment of different forms of income.

Finding 27: The Review finds that there is a case to provide more effective mechanisms to support age pensioners to maintain or take up paid work if they wish to do so. A concessional treatment of low to moderate levels of income from employment would better deal with the costs of work which are only partially offset in the current means test and be more effective than the current Pension Bonus Scheme.

Finding 28: The Review finds that a deeming approach for account-based superannuation products would remove the current distortion in the pattern of payment of pensions to pensioners with such income and assist in equalising the treatment of superannuation products and other financial assets. (Section 7.5.3)

In relation to eligibility criteria for pensions, the Review considered that pensions for those of working age should where possible build stronger links with workforce participation. Therefore the Review developed a finding in relation to the degree to which the Carer Payment and Disability Support Pension actively encourage workforce participation.

The Review has also developed a finding in relation to the eligibility age for the Age Pension, reflecting increased longevity and the impact this has on the sustainability of the retirement income system.

Finding 29: The Review finds that the Carer Payment and Disability Support Pension should more actively address questions of workforce participation. This focus needs to be effectively integrated into initial eligibility, policies to promote participation while people are on the payments and in ensuring that, where they have the capacity to support themselves and are no longer eligible for the pension, they can successfully establish or re-establish themselves in the workforce. (Section 7.6.1)

Finding 30: The Review finds that there is a case for a phased increase in the Age Pension age starting from 2014, when the Age Pension age for women will be the same as for men. Such a policy would improve retirement outcomes and support Australia’s capacity to address the impact of population ageing. It would reflect the strong increases in life expectancy the nation has experienced, which are expected to continue. Any reform would need to be part of a coordinated approach to retirement, including bringing the settings of the superannuation system into line with the Age Pension age. (Section 7.6.2)

7.1 Terms of reference

Two terms of reference are specifically addressed in this chapter: the first, which addresses ‘appropriate levels of income support’; and the third, which addresses the ‘structure of and payment of concessions or other entitlements’.

The Review’s findings on the appropriate levels of income support were presented in Chapter 3, which focused on the adequacy of the pension for those who are wholly reliant on the pension. This chapter focuses on the question of the appropriate level of income support for those who have additional private resources and low to moderate reliance on the pension.

This chapter also considers the sustainability issues identified in Chapter 2. Here the focus is on the impact of the pension means test on incentives to work and save, as well as the interaction between the pension system and the superannuation system. While the Review considers that these issues are important to its consideration of its terms of reference, it should be noted that the primary mechanism for consideration of these is the Australia’s Future Tax System Review.

7.2 The means test

The means test is the primary mechanism for determining the rate of pension payment made to individual pensioners. With the exception of a period in the 1970s when means testing was abolished for certain groups of older age pensioners, income support payments in Australia have always been targeted through means testing.

Settings for the means test have varied between payments and over time. This has occurred in response to a range of different priorities and circumstances. Drivers of change have included different notions of need, equity or fairness; different views on the balance between the support that should be provided to pensioners and the funding burden placed on taxpayers; to complement taxation and industrial relations policy settings; and to provide incentives for behavioural change in individuals or families in areas such as employment, saving, education and child-rearing.

7.2.1 The role of means testing

The primary purpose of means testing is to target the payment of income support to those most in need. That is, while the pension system in Australia is primarily directed at providing an adequate level of income to those who are unable or not expected to support themselves, means testing is the mechanism that withdraws assistance as private capacity increases.

This task is made complex because, as discussed in Chapter 2, means testing needs to target payments in a way that does not induce inappropriate behavioural responses, and which is seen as fair and equitable. To achieve this, balances need to be struck:

between effectively targeting assistance and minimising disincentives for employment and savings, including not unfairly penalising, or discouraging, those who seek to provide for themselves
between the level of assistance and the impost on taxpayers who ultimately fund spending on pensions.

Because means testing of retirement incomes operates in an area of often complex financial arrangements, its structure and operation are also inevitably complex.

The Review has therefore considered whether the balance of means testing is right by reference to three principles:

targeting pension assistance to those most in need
ensuring that incentives remain for people to provide for themselves through savings or work
ensuring within the pension system that people with similar levels of means and financial circumstances receive similar levels of income support.

In addition, it is important that the operation of means testing effectively integrates the pension system, in particular for age pensioners, with the broader retirement income system including superannuation, so that these mechanisms together can effectively address the key longevity, investment and inflation risks that are important to provide security for pensioners and ensure the sustainability of the tax-transfer system.

One of the mechanisms that contributes to this integration, as discussed in Chapter 6, is the CSHC which provides a transition between the benefits made available to age pensioners and those older Australians with more substantial means.

7.2.2 The design of the means test

Pensions are subject to two means tests: an income test and an assets test. Administratively, a person’s entitlement to a pension is assessed under both tests, with payment then being made at the lower of the rates they determine.

Structurally, the means test comprises two elements, a ‘free area’ and a ‘withdrawal rate’.

Free areas permit people to have certain levels of income or assets without affecting their pension. In addition to reducing the administrative burden, this ensures that people face no disincentives to acquiring low to moderate levels of private means, and allows for the costs of gaining the income including some costs of employment.
Withdrawal rates, also known as ‘tapers’, operate to ensure that the rate at which the pension is reduced at higher levels of private means is such that people with higher levels of assessable means are still financially better off in net terms from having private means.

These structural elements are supported by a series of definitions of assets and income, and exemptions that determine whether and how private means are assessed. The objective of these settings is to ensure that people in effectively similar financial circumstances receive similar levels of support. (The extent to which this actually occurs is considered in Section 7.5.2.)

Current income and assets test parameters are detailed in Table 5 and Table 6.

Under the income test, the level of the potential pension payable is reduced by 40 cents for each dollar of private assessable income over the free area.

The assets test operates by reducing the potential pension by $1.50 a fortnight for each $1,000 of assessable assets over the free area amounts. This equates to a $39 reduction in pension a year for each $1,000 of assets above the free area.

Table 5 Income test: main parameters, 1 January 2009
Family situation	Maximum pension is paid if assessed income is up to		No pension is payable if assessed income exceeds
Family situation	Fortnightly ($)	Annually ($)	Fortnightly ($)	Annually ($)
Single pensioner	138.00	3,588.00	1,558.25	40,514.50
Pensioner couple (combined)	240.00	6,240.00	2,602.50	67,665.00
Single pensioner with one child	162.60	4,227.60	1,582.85	41,154.10

Notes: Pension cut-out point is higher for people receiving Rent Assistance.

Table 6 Assets test: main parameters, 1 January 2009
Family situation	Maximum pension is paid if assessable assets are up to ($)	No pension is payable if assessable assets exceed ($)
Single home owner	171,750	550,500
Single non-home owner	296,250	675,000
Partnered home owner (combined)	243,500	873,500
Partnered non-home owner (combined)	368,000	998.000

Notes: Pension cut-out point is higher for people receiving Rent Assistance.

As shown in Table 5 and Table 6, pension free areas and cut-outs differ depending on household circumstances and whether they own their own home.

Single pensioners, single pensioners with a child and couples are all treated differently. In addition to the thresholds shown in the tables, there are more specific thresholds covering circumstances such as couples separated by illness.
Non-home owners have a higher free area under the assets test than home owners. This partially compensates for the benefit that home owners receive from the exemption of the family home from the assets test.

The operation of means testing and the outcomes for different groups of pensioners are also affected by the definition of which income and assets are ‘assessable’ or ‘exempt’ from means testing, and the particular treatment of different sorts of assets and income.

In the case of the assets test, the two significant exempt assets are a person’s owner-occupied house, or in some cases the proceeds of the sale of the house, and for pensioners under Age Pension age, superannuation assets. Other exemptions are relatively minor and cover items such as funeral savings and aids for people with disability.
The income test is more complex:
- Income from employment and from ‘non-financial assets’ such as real estate is assessed on an actual income basis.
- Income from ‘financial investments’ like bank deposits and shares is assessed on a ‘deemed’ basis—that is, based on the asset value, rather than the actual income received by the pensioner.
- In most cases lump-sum receipts, such as gifts, the proceeds of the sale of a house, and loans (including reverse mortgages), are not counted as income as they are received, but may be assessed if these amounts are invested in other assets.
- A more complex set of rules exist around superannuation income.

These tests are discussed in more detail in Section 7.5.3.

7.2.3 Operation of means testing for pensioners

While the means test operates by way of single tapers, the actual relationship between increasing private income and net income is much more complex. This is largely the result of interactions with the tax system, but also because of the way in which some additional allowances are withdrawn.

Because of the interaction with the tax system, the relationship also differs for various groups of pensioners and types of income. Of particular note in this regard are the tax offsets such as the Senior Australians Tax Offset, which is age-related, and the Mature Age Workers Tax Offset, which is again dependent on age and applies to earned income only.

These interactions are shown in Chart 24, which illustrates effective marginal tax rates. An effective marginal tax rate is the proportion of an increment of private income that, due to imposts such as taxation and reduced payments due to the means test, does not flow through to net disposable income. The chart shows effective marginal tax rates on increments of $10 a week of private income. The chart also shows, at each point the components of the tax-transfer system that are responsible for the rate.

In the case illustrated, that of a single age pensioner whose private income is earnings, the effective marginal tax rate is initially zero while earnings are within the free area before rising to 40 per cent as the income test withdrawal rate operates. While initially any tax impact is offset by increasing tax offsets, at around $20,800 a year a more substantial interaction occurs as the value of the offsets reduce and the Medicare Levy begins to shade in. There is then a spike at around $40,000 associated with the loss of Utilities Allowance. The effective tax rate then drops, and while initially higher due to the withdrawal of the Senior Australians Tax Offset, it falls to the marginal tax rate at some $46,800, before a final spike associated with the withdrawal of the Seniors Concession Allowance.

Chart 24 Effective marginal tax rates—single age pensioner, January 2009

Notes: Effective marginal tax rates shown are on the next $520 a year ($10 a week) increment of earnings, at each $520 earnings point. Effective marginal tax rates vary between pensioners depending on factors including the type of pension, the type and source of income and the pensioner’s age.

Source: Review modelling.

While this pattern appears to be very complex, the reality of its impact on the disposable income of pensioners is somewhat smoother. Chart 25 illustrates how, with the exception of the point at which the Seniors Concession Allowance is withdrawn, additional earnings increase the disposable income of the pensioner, notwithstanding the tapering away of the pension.

Chart 25 Private income and disposable income—single age pensioner, January 2009

Notes: The disposable income level in the chart does not include the value of bonus payments such as the Seniors Bonus.

Source: Review modelling.

Charts 24 and 25 illustrate the operation of the pension income test. It should be noted that at points above a moderate level of assets the assets test generates higher effective marginal tax rates and different impacts on total disposable income (Section 7.5.2 discusses the assets test in more detail).

7.3 What the consultations told us

As discussed in Chapter 3, there was a fundamental divergence in the views expressed in the consultations about what people see as a ‘fair pension system’. In the context of means testing, while some believed the test should be eliminated or relaxed, as they saw the pension as a ‘right’, others believed it should be tightened to better target pensions to those with least private means.

7.3.1 Consultations—the pension as an entitlement

The theme of a ‘right’ to the pension, particularly the Age Pension, and means testing of pension payments as either inappropriate or too harsh, was a feature of all consultations.

At the public forums and other consultations, many pensioners expressed their belief that they had ‘earned’ the right to an Age Pension in retirement through having paid taxes over their working lives. These participants indicated that they saw it as unfair that the means test operated effectively as a high marginal tax rate on earned income, and as a penalty for having built wealth over a lifetime.

This view was more marked in the written submissions. Around 19 per cent of submissions from age pensioners supported the view that age pensioners had already earned the right to the pension through a lifetime of work and paying taxes.

7.3.2 Consultations—adequacy of part-rate pensions

Overall, while many submissions to the Review came from pensioners who were on a part-rate pension and raised concerns about the living standards these pensioners could achieve, the extent of adverse outcomes indicated in these was considerably less than that raised in submissions from those who were wholly reliant on the pension.

This was also seen in the focus groups, where participants were asked a series of questions about their satisfaction with income support payments, standard of living, ability to meet daily living costs, financial security and comparative standard of living. Part-rate pensioners consistently reported having better outcomes against all measures than pensioners receiving the maximum rate.

7.3.3 Consultations—incentives to work

Many of the pensioners participating in the public forums indicated that they would like to undertake some part-time work but felt that this was discouraged by the income test. This view was reinforced by many focus group participants: more than one-third of participants expressed a strong interest in performing paid work of some sort, even though participants involved in the focus groups were either older than Age Pension age, had a disability which significantly affected their capacity to work, or were caring full-time for someone else.

There were repeated calls in all consultations for work incentives to be improved:

One-third of public forum participants who submitted self-completion forms³⁵ called for improvements to work incentives through relaxing income test thresholds or the tax treatment of earnings.
Around 18 per cent of age pensioners and 20 per cent of organisations who made a written submission called for a more generous treatment of earned income.
More than three-quarters of focus group participants (who indicated they were able to work) thought that the current design of the pension system did little to encourage people to take up work.

Reasons to participate in employment

In addition to the financial gain, paid employment was seen as helping to maintain a balanced and active lifestyle. Some submissions talked about the social, mental and physical benefits of work, arguing that the government should encourage pensioners to undertake some paid work, if pensioners wish to. Some submissions suggested that participation in the workforce could save the community money in the long term through reduced health and welfare costs. Around 11 per cent of submissions from organisations mentioned the benefits of pensioners being in work.

This perspective was also reflected by focus group participants, who saw work as having many objectives: as a way to supplement their income, as an opportunity for stimulation and social interaction, and as a means of ‘giving something back’ and making a useful contribution.

Barriers to employment

A consistent theme across the consultations was that pensioners felt, because of the pension income test, that there was little or no financial incentive to work.

Participants in the public forums generally saw the pension taper rate as a tax, and pointed out that outside the social security system only high-income earners face a 40 per cent tax rate. Participants also thought that they should be able to earn more than $69 a week (for singles) before it affected their pension.

This view was also reflected in the written submissions and focus groups. Some submissions argued that current income test arrangements resulted in part-time work being of little or no economic benefit to many pensioners, even though they were keen to participate in the workforce. Some focus group participants stated that it simply cost too much to go back to work.

Some participants criticised the complexity of the means testing rules, which can make it difficult to identify how undertaking extra work or saving money might affect pension payments.

Participants in the public forums also felt that the costs associated with looking for and travelling to work were not sufficiently recognised in the setting of means test thresholds.

In addition to the income test issues, many people receiving Disability Support Pension spoke of the difficulty of finding suitable employment, the negative attitudes of some employers towards people with disability, and the challenges posed by the current work capacity assessment process required to qualify for payment.

7.3.4 Consultations—the assets test

About 8 per cent of submissions from individuals and 9 per cent from organisations called for assets test thresholds to be reviewed or for the assets test to be abolished. Several were concerned that savings gained from work and careful budgeting were being included in income and assets tests, even if those savings were being held for purposes such as home maintenance, car repairs or appliance replacement.³⁶

Other submissions expressed concerns at what people felt was a harsh means test treatment of non-productive, high-value assets, such as holiday homes and non-productive farms, from which they derived no income, but because of which they were entitled to little, if any, pension payment.³⁷ Similarly, there was criticism of gifting rules and the treatment of overseas pensions.

Older participants in the public forums argued that they had no opportunity to benefit from the introduction of the Superannuation Guarantee and that the policy settings in place during their working lives actively encouraged investment in the family home rather than saving for retirement.

7.3.5 Consultations—targeting and sustainability

Balancing these views that means testing should be relaxed were views that there was a need to better target assistance to those with the least means. Some submissions, mainly from peak organisations, but also some individuals, called for tightening of means test rules for people with significant private income or assets. These submissions argued that tighter targeting of pensions to those most in need was required to maintain a fiscally sustainable pension system.

7.4 Reform directions and sustainability

The Review identified a number of important short- and long-term priorities that need to be taken into account in considering possible changes to the means testing and targeting of pensions.

The group of short-term issues principally flow from other findings of the Review. A key question is whether, if there was an increase in the pension rate to meet the objective of adequacy for those wholly reliant on income support, it would be appropriate for this to flow on to those with higher private incomes and low to moderate reliance on the pension. In addition, there are a number of areas where reform is needed to ensure that the income and assets tests operate effectively and efficiently.

As discussed in Chapter 2, the long-term sustainability of the pension system is a crucial issue for governments, and for pensioners: financial security can only be achieved for pensioners if the pension system is sustainable.

These longer-term issues are discussed in Section 7.5 and Section 7.6. However, the Review recognises that many of the issues of long-term sustainability are best considered in the broader context of the Australia’s Future Tax System Review. The Pension Review has considered these issues to ensure that its findings are soundly based, and to ensure that the shorter-term reform directions that it has identified are compatible with the longer-term directions that might be taken by the Australia’s Future Tax System Review.

7.4.1 Role of the Age Pension

Before discussing the reform directions for the means test, the Review considers that it should address one area where its view of the role of the pension system is at odds with the views presented in consultations.

In the consultations there was a strong view that the Age Pension is a right and that means testing is inappropriate because pensioners consider that they have earned the pension. As discussed in Chapter 2, while this may be appropriate for overseas models of contributory social insurance, it is not appropriate for Australia’s income support system. The Review considers that Australia’s model of pensions is different: the payment of pensions is primarily driven by the objective of providing an adequate level of income to those unable or not required to support themselves.

The view that pensioners have ‘pre-paid’ their pensions is also out of line with current policy settings. Pensions are paid out of current receipts and by current taxpayers. Indeed, with the changing structure and size of the population, current and future cohorts will be required to provide support to a much larger population of pensioners than has been the case for earlier generations.

It should also be noted that even at current values for the pension, and despite the perceptions of many, for a large proportion of the population, the level of taxation they have paid, even if wholly allocated to the pension, would not have been sufficient to fund the current rates of pension over current projected lifetimes.

An important consequence of this perspective is, as discussed in this report, the question of equity between pensioners and taxpayers, and in particular the extent to which a pensioner with private income can be receiving some pension payments generating a level of income on which a non-pensioner would be a net taxpayer.

If the pension were a pre-paid entitlement, this might not be seen as an issue. When the pension is a targeted payment based on need as well as eligibility criteria, means testing must be considered.

7.5 Reform directions—means testing

Three key aspects of means testing have been considered by the Review:

The appropriateness of the levels of pension payments to pensioners with private means.
The relationship between the income and assets tests.
The definition and treatment of particular types of income and assets.

7.5.1 Appropriate levels of pension payment

Chapter 3 considered the question of appropriate rates of pension for those who wholly rely on it. To address the terms of reference in relation to appropriateness of the levels of pension payment for those who have additional private means, the Review has focused on two questions:

Are the current rates of payment made to pensioners with private means appropriate, within the context of an income support system designed to achieve adequate outcomes and to ensure that there are incentives for self-provision?
If the rate of pension were increased to improve adequacy for some groups of pensioners who are wholly reliant on income support, would there be the same need for these payments to be passed on to pensioners with low to moderate reliance on income support?

This section considers four specific issues associated with the appropriateness of the levels of payment made to pensioners who have private means and are affected by the means test:

incentives and how these impact on behaviour
the current outcomes for these pensioners
the implications of any change in the rate of pension
the effects of possible short-term changes on the outcomes of the Superannuation Guarantee.

The impact of incentives

The means testing of pensions needs to balance the objective of targeting taxpayer-funded transfers against the equity and efficiency impacts of high effective marginal tax rates, which introduce disincentives for participation and savings.

However, the impact of incentives on behaviour is complex.

The existence of a social safety net may result in a willingness to accept risk and a lower commitment to self-provision. While the first of these can be seen as a positive when it is reflected in areas such as labour market flexibility, the second can result in a willingness to rely on the safety net which does not benefit the individual and costs the community.
The outcomes of effective marginal tax rates also depend on both income and incentive/substitution effects. While some people may respond to higher effective tax rates by reducing effort because of the trade-off between leisure and income, others may respond by increasing their effort so as to achieve the same level of income they would otherwise have received.
In practical terms, there are also inter-temporal impacts that need to be taken into account. In the case of the Age Pension, for example, a shift in the means test treatment of assets, while potentially causing a behavioural shift by those in employment who are accumulating assets, may have little impact on the behaviour of current pensioners who have little scope to change their level of assets.
In such cases where behaviour is inelastic in the short term but elastic in the longer term, the short-term consequences of policy may be quite different to the longer-term goal. At least in the short term, policies intended to encourage the accumulation of private means may result in an increase in government outlays because of higher rates of pension being paid to those people on a part rate of pension, while any reduction in outlays due to increased savings as a result of the change in incentives may not be obtained for many decades.

Therefore, while the Review considers that the incentive effects of means test design are important, the final impact on behaviour and outcomes is a result of many factors and cannot always be accurately predicted.

Current outcomes

Four approaches were considered in trying to measure the outcomes of the current means test regime:

the current distribution of average effective tax rates
the cut-out points of payments
whether there is evidence that the current pattern of incentives is introducing distortions in behaviour
the levels of wellbeing achieved by pensioners.

Effective tax rates

The impact of means testing is illustrated in Chart 24, which shows that, with the exception of some spikes, effective marginal tax rates remain below the point at which a person would see their disposable income drop if they were to gain an additional dollar of private income—a situation often referred to as a ‘poverty trap’.

The pattern of incentives is also considered in Chart 26. In these charts the focus is on the average effective tax rates for age pensioners. Average effective tax rates measure the amount of pension withdrawn and tax paid as a proportion of private income in a cumulative sense from the first dollar of income. They provide a different view of the impact of income testing than effective marginal tax rates for a number of reasons. Average effective tax rates are less volatile than effective marginal tax rates. They take account of the fact that income changes can be ‘lumpy’, moving from one point to another, rather than moving in small dollar increments; and unlike effective marginal tax rates, they take account of the role of free areas across the income range.

Along with these average effective tax rates, Chart 26 also shows the distribution of the current age pensioner population.

Chart 26 Average effective tax rates from first dollar of income, age pensioners

Single Pensioners Couple Pensioners

Chart 26 Average effective tax rates from first dollar of income, age pensioners

Notes: The distribution of pensioners by private assessable income is at December 2008.

The AETRs are at 1 January 2009 and are generated by earned income. In the chart regarding couples, all the private assessable income is earned by one member of each couple.

While average effective tax rates reach levels of around 50 per cent (slightly lower for single pensioners and slightly higher for couples), these rates are only generated at quite high levels of private income. In the case of a single pensioner, the average effective tax rate reaches 30 per cent for a pensioner with a private income of around $14,000, and for a couple it reaches 50 per cent for private incomes above $48,500. These rates are, however, of course well above the actual tax rates paid by working age taxpayers with similar levels of income.

In both cases, these high rates only affect a small proportion of the population. For single pensioners, 68 per cent of all pensioners have income within the free area only and hence face no withdrawal rate at all. More than 80 per cent have average effective tax rates of under 20 per cent, and less than 2 per cent face rates at or above 47 per cent. The situation is similar for couples. The average effective tax rates in the couple pensioners graph show that around 80 per cent have incomes below the free area and 76 per cent have average effective tax rates of under 20 per cent, with less than 4 per cent experiencing a rate of 50 per cent or higher.

It should also be noted that Chart 26 illustrates outcomes where the private income is from earnings. As discussed above, where the private income is from investments or bank savings, the means test ‘deems’ that the pensioner receives an income. To the extent that a pensioner obtains an actual return that is higher than the deeming rate, average effective tax rates on their actual private income can be significantly less.

Chart 26 illustrates the operation of the income test. Higher average effective tax rates can apply to asset-tested pensioners (Section 7.5.2 discusses the assets test).

Pension cut-out points

A consequence of current means testing parameters is that, while the primary purpose of the pension system is to assist those with limited means, a part rate of pension can be received by people with relatively high levels of personal resources. Under current policy settings a single pensioner can have a private income of $40,514.50 a year before their pension entitlement is extinguished, while a couple can have an income of $67,665. If pensioners receive Rent Assistance, their cut-outs are higher than these figures.

By community standards these levels of means are quite high. The cut-out for a single pensioner is equal to the gross earnings of a full-time worker at the 30^th percentile of the earnings distribution, while that for a couple is the equivalent of a worker at around the 73^rd percentile of full-time earnings. When compared with the incomes of taxpayers, the cut-out for a single person is around the 47^th percentile of taxpayers and for a couple around the 78^th percentile.

Impact of cut-out and related points

As the pattern of effective marginal tax rates is not consistent across the range of income, incentives will vary. A particular concern in pension design is whether or not these variations introduce distortions in people’s behaviour. While there are many anecdotal reports of pensioners seeking to adjust their financial affairs to minimise the impact of means testing, or to maintain the particular benefits associated with access to concession cards, this type of behaviour is much harder to capture in analysis.

If these means test thresholds had a strong behavioural impact, it would be expected that the distribution of pensioners by their level of assessable private income would show a concentration at points just below the free-area thresholds and pension cut-outs, and in the case of the free area, a compensating reduction in numbers immediately above this point.

As is shown in Chart 27, no such distortion appears in the distribution of age pensioners, either around the cut-out of the free area for pensioners or at the cut-out point for receipt of any pension payment.

Chart 27 Distribution of age pensioners by private income, December 2008

Free Area Cut Out

Chart 27 Distribution of age pensioners by private income, December 2008

Note: The free areas and cut-outs are at 1 January 2009.

The cut-outs refer to pensioners who do not receive Rent Assistance.

Source: Review modelling and administrative data.

These distributions suggest that the current structure of means testing is not introducing a significant degree of distortion, or in the case of the cut-out point of the pension that the CSHC is effective in eliminating a ‘sudden death’ cut-off in support which may otherwise encourage people to maintain pension eligibility even if they only received minimal income support from this.

Wellbeing

Wellbeing outcomes were discussed in Chapter 3. This analysis indicated that across a range of measures it was clear that those pensioners who had private means had more positive outcomes than those who were wholly, or close to wholly, reliant on income support.

These findings were confirmed in the focus groups conducted by the Review. Across the set of questions that they were asked, part-rate pensioners reported higher levels of satisfaction with the rate of the pension, their standard of living, and how their standard of living compared to the community as a whole.

Summary of current outcomes

Taking these four aspects together, the Review considers that there is no evidence that the current means testing of pensions is leading to an inappropriately low level of pension payment to those pensioners with private means. In particular, wellbeing analysis does not indicate a need for concern about the adequacy of the rate of the pension received by groups with low and moderate reliance on pensions.

Impact of changes to the base rate of payment

As indicated in Section 7.4, one immediate short term issue considered by the Review was the implication for those with low to moderate reliance on the pension, of a change based on the adequacy of pension rates for these wholly reliant on the pension.

Under current means test arrangements, such a flow-on occurs automatically unless there are changes in the means test parameters. In contrast to this, the Review considers that any increase should be targeted. This issue is considered here with regard to the income test. Because of complexities in the interaction of the income and assets test, the assets test is discussed separately in Section 7.5.2.

A threshold question is whether the parameters of the income test can be tightened without adversely affecting incentives to work and save.

The Review considers that the analysis of marginal and average taxation rates above demonstrates that there is, in the context of an increase in the maximum rate of pension, some capacity for moderate tightening of the income test settings without adversely affecting incentives to work and save.
The Review considers that this also holds for the Age Pension’s role in providing a foundation for the replacement rates achieved by individuals through the Superannuation Guarantee. In the context of an increase in the maximum rate of pension, it would be possible to moderately tighten income test settings without significant adverse effects on the replacement rates achieved by the combination of the Age Pension and the Superannuation Guarantee.

Therefore, the Review considers that in the case of an increase in the pension rate, there is the capacity to tighten income test settings to prevent the increase flowing to pensioners with low and moderate reliance on the pension.

Limiting the flow-on could be undertaken in two ways: by a reduction in the free area of the means test or by an increase in gradient of the taper rate.

While either a reduction in the income test free area or an increase in the income test taper rate would increase the average effective tax rate faced by pensioners, the points at which they impact differ. A reduction in the free area increases the average effective tax rate at the lower end of private incomes, with the most marked effect at incomes between the old and the new free areas. In contrast, an increase in the taper rate has a much smaller impact on those with low private incomes and a relatively stronger impact at higher levels of private income distribution.

It should also be noted that the issue of incentives to work and save, arising from the interactions of the tax-transfer system, and the interaction of the Age Pension and the Superannuation Guarantee, are being considered in the wider Australia’s Future Tax System Review. That review will, in this context, identify long-term reform directions for the pension means test. The Pension Review has developed its findings in this area within the context of the current structure of means testing, and with a view to developing shorter-term reforms that do not pre-empt future reform direction that might be developed by the wider Review.

7.5.2 Relationship between income and assets test

The rate of pension a person is entitled to is the lower of the rates generated by the income test and the assets test. The concept of taking account of both income and assets in determining pension rates has been the predominant form of means testing over the history of Australian pensions, with the exception of the period between 1976 and 1984. The way in which this has been done has varied. The current structure of the tests largely reflects the approach implemented in 1985.

Within the current two test structure, the Review considers that the income and assets tests should act in a complementary way:

The income test should be the primary test, taking account of the income a person has from employment and other sources, such as a deemed return on financial assets.
The assets test should be a supplementary mechanism to address those situations where a person may have had significant non-financial wealth that they do not effectively use for self-support.

In this design, the assets test should be essentially a pragmatic mechanism to capture the small proportion of the population with significant assets in a form that does not generate income, and to discourage people from seeking to move their wealth into assets that do not form part of the income test. This objective is incorporated into the assets test by taking one approach to all assets, and through a very sharp withdrawal rate.

There are also operational efficiency and simplification arguments for placing a greater reliance on the income test as the primary mechanism. Income is usually easier to identify and value than assets, in particular non-financial assets. Non-financial assets, which include items such as holiday homes, non-productive farms and artworks, often require professional valuation. These valuations can be very volatile reflecting the nature of markets, which can add considerably to the complexity and onerous burden placed on applicants, especially when valuations are contested.

The relative roles of the two tests are reflected in the pension system. However, the balance between the tests has been changing over time. Currently, around 9 per cent of all age pensioners receive a reduced rate of pension due to the assets test, compared with 32 per cent due to the income test. New entrants to the pension system are more likely to have higher assets than existing pensioners and to be affected by the assets test. The proportion of new entrants for the 12 months to December 2008 who received a part-rate pension due to the assets test was around 24 per cent.³⁸ This difference in the asset levels of the stock of age pensioners and new entrants is in part due to growth in real wealth and in part to the fact that some age pensioners deplete their assets over time.

Age pensioners today are also more likely to receive a part-rate pension due to the assets test than in past decades due to the indexation arrangements discussed in Chapter 4. These arrangements mean that the value of the threshold for the assets test has fallen in relative terms when compared with the pension rate. This is illustrated in Chart 28. While the cut-out point for pensioners has increased over time under the assets test, primarily because of changes in the taper rate, the assets test free area has declined in relative terms. The result is that the assets test can now be the primary test for pensioners with moderate financial assets alone, which in principle, should be captured through the income test. This reflects the fact that this parameter, as discussed in Chapter 4, is indexed by the Consumer Price Index alone.

Chart 28 Assets test settings, home owner couples, 1985–2009

Notes: Assets test threshold and point where no pension payable expressed as multiples of annual rate of pension.

Source: Review calculations

Another way of conceptualising the relative impact of the assets and income tests is to compare the way in which the assets test would effectively be operating if all the assets were generating an income and the value of this income was compared to the levels of pension payable. This approach is illustrated in Chart 29 which, for a homeowner couple, shows the rate of pension that would be paid with different levels of private income, under the income test, and then how the assets test actually operates assuming all assets were financial and generated a rate of return of 5 per cent. While initially more generous, the assets test then operates aggressively and reduces the pension entitlement rapidly. For example, at levels of assets of around $370,000 (an amount that would produce a weekly income of $356 a week), the assets test would result in a lower pension than the income test.

However, because most pensioners also have personal assets—such as cars, clothing and furniture—that are incorporated into the assets test, the cross-over point between the two tests is reduced even more in the real world. In the case of a couple with, say, $60,000 in personal assets, the cross-over would occur when they have financial assets of around $250,000. This level of financial assets is becoming increasingly more common as people build up superannuation savings.

The lower the deeming rate on financial assets (at the time of finalising this report, these rates were 3 per cent and 4 per cent), the more stringent is the relative impact of the assets test in its current settings.

Chart 29 Couples, illustrative impact of the income and assets tests

Source: Review modelling.

In summary, the Review’s concerns are that the assets test, rather than acting as a backup, can now operate as the primary test for some pensioners with relatively moderate levels of financial assets which would be better assessed under the income test. Instead of this group of pensioners being income tested on the value of their income, their pension is reduced on the basis of the wealth that was generating this income. This means that the income and assets tests are not interacting efficiently and effectively.

These trends and pressures on the assets test parameters were a part of the context of the reduction of the assets test taper rate from $3.00 to $1.50 in September 2007.

However, in contrast to the operation of the income test and the treatment of earned income and superannuation, the review considers that it is not possible to develop shorter term reform directions for the interaction of the income and asset test without pre-empting future longer term reform direction, that might be developed by the Australia’s Future Tax System Review. The Review notes that the Australia’s Future Tax System Review Panel has identified the overall design of the means test as a potential issue in its consultation paper on the retirement income system.

7.5.3 Scope and definitions of income and assets

The definitions of income and assets and the way in which particular items are treated in the means test have consequences for the rate of payment of pensioners. Five specific issues considered here are:

the assessment of earned income
the way in which superannuation income is assessed
the treatment of the family home
the tax treatment of pensions.

In addition to these specific areas, the Review first considers more generally the definition of income and the role of deeming.

Assessment of income

Various types of income are assessed differently for the purpose of the pension income test. The broad approaches to assessment are shown in Table 7. As illustrated, while in some cases income is simply assessed on the basis of receipts, in other cases it is assessed on a deemed basis. That is, rather than the actual amount of income a pensioner may obtain from their financial investments, such as bank accounts and shares, a value of income is ‘deemed’ based on the value of the asset and a ‘deeming rate’.

The primary purpose of deeming is to ensure that pensioners utilise their assets effectively, in particular in a historical context where many pensioners held their savings in very low interest bank deposits, and to address the extent to which returns on shares were taken both as dividend income and as capital gains. As noted in the discussion of effective marginal tax rates, where a pensioner obtains a rate of return above these rates the pensioner is income tested on the deemed rate only, and hence the effective tax rate may be well below the nominal rate.

Deeming rates are adjusted to reflect the returns available in the market by the Minister for Families, Housing, Community Services and Indigenous Affairs on the basis of advice from that department. Current deeming rates are 3 per cent for the $41,000 of financial assets held by a single pensioner or $68,200 for a couple, and 4 per cent on amounts above this.

Table 7 Assessment of income
Income assessed	Type of income
Amounts earned, derived or received, including from:	Employment (including fringe benefits) (gross amounts) DVA payments and overseas pensions Real estate and businesses including farms (net amounts) Certain remunerative lump sums Boarders and lodgers Some periodical payments by way of gifts or allowances Leave or redundancy payments from an employer
Assessable income is calculated by reducing the annual payments paid from the income stream by an amount that reflects a return of the purchase price.	Income streams with a term of more than five years
The deemed amount from financial assets:	Money in a bank, term deposits, managed investments, listed securities Gold and other bullion Certain income streams (with a term of five years or less) Approved deposit funds, deferred annuities and superfund investments held by people over Age Pension age Loans including those to family trusts and companies Gifts of money or assets over $10,000 a year or over $30,000 over five years
Lump-sum amounts apportioned over 52 weeks:	Distribution from a family trust Commission or royalty Profits, for example, distribution from a profit-sharing agreement Grant or scholarship Payments to a professional sports person, for example, endorsement payments Dividend or distribution from a private unlisted company Certain ‘loan’ arrangements where there is no expectation that the loan will be repaid

Earned income and age pensioners

The treatment of earned income was a recurrent theme raised in the consultations. A significant group of pensioners indicated that they were discouraged from taking up employment by the extent to which this would lead to a reduction in their pension payments.

As the analysis in Chapter 2 indicated, continuing employment can be important for the benefits that accrue to individual pensioners (both financial and non-financial), and for the contribution that their participation in the workforce can make to society as a whole.

While these issues have relevance both to age pensioners, and those on working age payments, the focus of the Review’s consideration here are on age pensioners. There are three reasons for this.

Given the conditionality of the working age pensions and the close links between them, the labour market, and other working age payments, including eligibility for working credit, the issues for employment for these groups extend beyond the issue of incentives discussed in this section.
The need to develop a more effective support for participation by age pensioners as an alternative to the current Pension Bonus Scheme.
Specific issues around the relative treatment of earned and unearned income which are largely associated with the experience of age pensioners and their other forms of retirement income.

Section 7.6.1 considers the links between Carer Payment and Disability Support Pension and work force participation.

While the effective tax rate on private income in the pension system is not considered excessive when taken as a whole, the nature of employment income is somewhat different to investment income and other savings for two reasons.

The first concerns the direct costs of employment. While one of the purposes of the pension free area in the income test is to cover the costs of work, the free area is a relatively blunt instrument. It is insensitive to the actual costs of work which can vary with the time spent in employment and the level of income derived from it. In addition, to the extent many pensioners have some private investment income, this in effect has already absorbed the free area and if a pensioner commences employment there is no further offset for the additional costs of working.

The second issue relates to the extent to which age pensioners face a trade-off between the time they spend in employment and their leisure time. Because of the trade-off for leisure time, earned income involves an ‘opportunity cost’ to pensioners that is not associated with other income streams.³⁹

Taking these issues into account, and the importance of employment, the Review considers that there is a case to consider mechanisms that provide a stronger incentive for age pensioners to take up paid work, or to have transitions into retirement that allow for a combination of work and retirement.

The first part of such an approach could involve the concessional treatment of at least some earned income (income from work) in the income test.
The second part relates to the mechanics of the operation of the income test. The current approach is complex and involves ‘striking an annual rate’ of earnings which is particularly unsuited for responding to the higher degree of variability experienced in earnings-based income for some pensioners who undertake casual or irregular employment.

Such a change would provide a mechanism to replace the Pension Bonus Scheme.

In considering the return from employment for pensioners over Age Pension age, the Review was aware of the need to balance the objective of minimising disincentives for work by these pensioners with equity of treatment between pensioners and ordinary employees. This balance is already markedly in favour of pensioners who receive a higher disposable income for the same level of gross income than working-aged employees. For example, an age pensioner who is in employment and is paid the equivalent of the Federal Minimum Wage would currently have a disposable income of $627.84 a week. In contrast, a non-pensioner would have disposable income of $494.44 a week, $133 a week less.⁴⁰ A more concessional treatment of earned income would exacerbate this. For this reason, the extent of any concessional treatment may need to be capped.

Definitions of assessable superannuation

The assessment of superannuation income under the income test is complex. Much of this complexity arises from the evolving nature of superannuation in Australia and the complex taxation and other rules applying to it.

The most common forms in which pensioners take superannuation is as an income stream from an account-based product or as an annuity. In these cases a person is income tested on their ‘assessable income’, which is equal to the income they obtain less an ‘income deduction’. This deduction is equal to the initial value of the superannuation asset divided by a factor which is either the term of the income stream or life expectancy as derived from life tables.⁴¹

While the goal of this approach is to exclude assessing the withdrawal of capital, it has several consequences. The income deduction tends to ‘front-load’ the concessional treatment and provides a benefit even when individuals only partially use their superannuation over their retirement. That is, while in the initial period of drawing on superannuation a pensioner will largely be drawing on fund earnings, the ‘income deduction’ is conceptually based on them actually withdrawing capital. In contrast, in later years when they are more likely to be drawing on the capital, the ‘income deduction’ (which is not indexed) will have reduced in value and a higher proportion of the amount drawn down will be treated as if it were income. Similarly, if a person maintains the capital value of their superannuation, for motives of bequest or to protect against longevity risk, they remain entitled to the ‘income deduction’ despite the fact that they are not drawing down on the asset. A consequence of these effects is, for example, that a person in receipt of an inflation-indexed annuity will obtain a lower rate of pension in later years as the real value of the ‘income deduction’ declines, and their assessable income increases. The patterns that result from this and the operation of the assets test on the income of a person receiving a part pension are shown in Chart 30.

In addition to these specific distortions in the rate of pension payment over time, a more general question raised by this treatment of superannuation is the extent to which it introduces distortions in people’s choice of assets in retirement. Clearly the treatment is concessional relative to other financial assets.

Chart 30 Payment pattern of the Age Pension to a person with superannuation income

Note: Assumes a woman currently retiring with an account-based superannuation balance of $250,000 which is drawn down on the pattern of a CPI indexed annuity and non-financial assets of $50,000. Model parameters at Appendix E. Average annual retirement income is given in earnings discounted terms, that is, relative to the income of employed people.

Source: Review modelling.

The Review considers that there are strong grounds for changing this approach to remove the inappropriate ‘front-loading’ generated by this treatment, and to reduce any distortions in choices around the form in which assets are held. This would most simply be achieved by treating account-based superannuation in the same way as other financial assets under the income test; that is, assessing these superannuation products under the income test on the basis of income deemed from the current value of the superannuation asset. This approach would also complement any tightening of the income test by increasing the effectiveness of the income test treatment of account based superannuation products.

In addressing the treatment of account based superannuation products in the income test, the Review acknowledges that other issues arise in the assessment of a range of retirement income products, including those that may have both an income and an insurance component. In particular, the treatment of specific products can have a considerable bearing on the viability of products developed by the private sector to better assist older Australians to manage risk in their retirement. These issues are also being considered by the Australia’s Future Tax System Review.

Equity in the family home

In consultations, some organisations and individuals raised concerns about the exemption of owner-occupied housing from the assets test.

Some were concerned that this may not be fair or equitable to people who have homes of modest value, or who rent privately or rely on public housing. Others were concerned that the exemption may encourage people to ‘over invest’ in their family home, for example to maximise the rate of pension paid and to maximise the estate they can eventually pass on to their children, or may discourage ‘empty nesters’ and retirees from downsizing to accommodation which is more appropriate to their needs.

In some cases there were suggestions that the means test should be changed so that pensioners with very high value home equity are deemed to generate an assessable income stream from some of this equity.

Balanced against this, the exemption of the principal home from means testing has been a long-term feature of the social security system and home ownership can contribute significantly to the financial security of pensioners by reducing their housing costs in retirement. For many pensioners home ownership is actually used more deliberately as one of the mechanisms for managing longevity risk. The capital value of home ownership also plays a role in the funding of accommodation bonds for certain forms of residential care.

A more specific issue concerns the treatment of equity withdrawal from the principal home. Historically, one of the reasons for excluding owner-occupied housing from means testing has been that equity in the family home was considered to be relatively ‘illiquid’. This is less the case today with the emergence of mortgage ‘redraw’ and equity ‘draw-down’ products.⁴²

Under the means test, if a reverse equity mortgage is taken as a stream of income, then the amount drawn down is not counted in the income test. If taken as a lump sum, the first $40,000 is exempt from the assets test for up to 90 days. While these rules apply to any capital amount (for example, a loan), it is possible for pensioners to use their assets test–exempt home equity to draw down a significant income stream that is exempt from means testing.

The emergence of reverse mortgage products is an example of how the products offered by the private sector are evolving to meet changing preferences. However, these changes also raise issues for the pension means test. The first is a direct question of whether or not the treatment is appropriate relative to other assets. The second is the extent to which the settings may inappropriately encourage the use of products, without pensioners fully assessing factors such as the compounding ‘negative interest’ aspect that can lead to a relatively rapid reduction in equity over time and finally erode security of tenure.

The issue of neutrality of treatment was also raised with regard to a person who downsized their housing—usually cases where a large family home was sold and the person instead bought a smaller unit or apartment that was more appropriate to their needs. While there are transitional arrangements that enable proceeds from the sale of the old dwelling to be protected in the short term to permit the purchase of the new dwelling, where the value of the new dwelling is less than the old, the difference becomes an assessable asset. Pensioners pointed out that this meant that their pensions were reduced, despite no net change in total assets. Effects like this are likely when the assets holdings of a pensioner move between exempt and non-exempt classes. Obviously, while the pension entitlement is reduced, the pensioner has potentially more assets to use to support themselves. This highlights the importance of ensuring that the income and assets tests operate efficiently and effectively and are in balance.

The broader issues that the exemption of the principal base raises, including the question of neutrality in the treatment of assets to ensure efficient allocation, is being considered by the Australia’s Future Tax System Review.

Pension taxability

The financial outcomes of pensioners are also affected by how the pension interacts with the broader tax-transfer system. There are some differences in the taxation treatment of age pensioners, and disability support pensioners and of Carer Payment recipients above Age Pension age, and those below this age. While the pensions received by these older pensioners are treated as income for the purposes of income taxation, the pension income of those on Disability Support Pension who are under Age Pension age, and those on Carer Payment where both the carer and the person in receipt of care are under Age Pension age, is non-taxable.

The Review could find no clear rationale for the difference in approach, and could see no compelling reason to continue the tax exemption of pensions paid to working-age pensioners. Pensioners in all categories of pension engage in the workforce and the levels of participation do not seem to warrant this difference. Furthermore, other income support payments for working-aged people are taxable, and similar taxation rebates are provided for both working-aged pensioners and other beneficiaries. This again is an issue that falls more appropriately into the specific focus of the Australia’s Future Tax System Review.

7.6 Reform directions—targeting of and eligibility for pensions

A number of other parameters of pension policy directly affect the sustainability of the pension system. Apart from the means test, the most important of these are targeting and eligibility.

7.6.1 Disability Support Pension, Carer Payment and workforce participation

Earlier discussion has noted that both the Disability Support Pension and Carer Payment are conditional payments that take account of a person’s current circumstances and their ability to support themselves in the workforce.

Analysis by the Review has, however, indicated that:

Notwithstanding strong employment growth over the last 15 years, the number of people in receipt of Disability Support Pension and Carer Payment has increased, and historically levels of receipt tend to increase during periods of labour market downturn.
The level of workforce participation of these pensioners while in receipt of these payments is low.
When people move off these payments due to a change in their circumstances, a large proportion continue to be in receipt of income support.
In addition to the particular disability or caring responsibility that the individuals may have, their low levels of labour market attachment are frequently associated with low levels of individual human capital.

For these reasons, the Review considers that there is a need for a much stronger emphasis in these programs on achieving labour market participation, including:

ensuring that eligibility is appropriately targeted
providing appropriate incentives and support for workforce participation by those currently on the program.

The working credit provides a mechanism to support the work efforts of disability support pensioners, and other income support recipients, who are under Age Pension age by effectively allowing these pensioners to bank unused free areas up to a cap. The working credit in effect softens the initial effect on pensions of income from employment and is primarily designed to encourage initial engagement in the labour market.

Carer Payment

One of the means of ascertaining that a carer is providing full-time care is a cap on the number of hours a carer can be in paid work, currently set at 25 hours a week. While in many cases the level of care that a carer is required to provide leaves little opportunity for employment, this is not always the case, including where the person being cared for may have external activities such as day care and school. In this context the cap operates as a relatively blunt tool.

While for some carers care giving is ongoing, for others the need to provide care may be more short or medium term. In such cases, it is important that the program take account of the future workforce participation of carers in addition to their current activities. Without such support, many ex-carers may fail to make a transition back into employment when their caring responsibilities cease. This is particularly important in light of the analysis presented in the Review’s Background Paper, that even when entering into Carer Payment many carers had poor connections with the workforce and tended to move onto other forms of income support if they ceased caring.

Given this, the Review believes further consideration should be given to more robust eligibility criteria which focus on the actual level of care provided, rather than the use of a cap on the number of hours of work. Attention also needs to be given to more actively focus the program on building linkages with labour force participation, either alongside the caring task or to support future transitions into employment.

Disability Support Pension

The Disability Support Pension is part of a continuum of support to people with disability whose capacity to engage in employment can vary widely depending on the nature of the disability.

Under current assessment criteria, to be eligible for the Disability Support Pension a person needs to have a certain level of physical, intellectual or psychiatric impairment that inhibits their ability to work for 15 or more hours a week, or undertake training that would enable them to do so within two years. Moreover, a significant proportion of the current Disability Support Pension population qualified for this payment under earlier criteria that assessed work capacity on the basis of a 30-hour test⁴³, rules that continue to apply for their current period of Disability Support Pension receipt. This creates a strong incentive not to test the labour market. A person with disability, but a lower level of work restriction, who is currently jobless would be eligible for Newstart Allowance. Unlike Disability Support Pension recipients, recipients of Newstart Allowance are subject to mutual obligations including job search.

Many people on Disability Support Pension may have a capacity to undertake some employment, but few do so. Others, while not currently able to work, may have the capacity to undertake other forms of participation, such as study or volunteer work, which would not only have direct benefits but could also enhance their future capacity for employment.

In contrast to the potential of many disability support pensioners, the current approach of the payment is one that is largely conceived around the pension being a passive ongoing source of income. In some cases analysis suggests that the payment is being used by some as a form of early retirement and as an alternative to job search. The Review notes that the current differentials in the level of payment, income test treatment of earned income and mutual obligations between Disability Support Pension and Newstart Allowance create an incentive for people to seek Disability Support Pension even when Newstart Allowance may be more appropriate.

The Review considers that the current passive orientation of Disability Support Pension is inappropriate in terms of both the outcomes for this group of pensioners and national goals of improving participation.

Specific issues that require further consideration in order to achieve such a refocusing are:

improved assessment procedures to ensure that people are not inappropriately placed on Disability Support Pension
stronger support for the employment of disability support pensioners and other people with disability including addressing service issues raised in Chapter 6
a more proactive approach to the current population of disability support pensioners, in particular those with higher work capacities than the current eligibility cut-out.

7.6.2 Age of eligibility for Age Pension

The age of eligibility for men for the Age Pension has been 65 years since the inception of the pension in 1909. The age for women, which was initially set at 65 years and then reduced to 60 years, is, following a decision in 1994, being raised again to 65 years. The current age of eligibility for women is 63.5 years and will reach 65 years in 2014.

In the light of its terms of reference and the need to ensure the long-term sustainability of the pension system, the Review considers there is a need to assess whether these ages continue to be appropriate.

The demographic context

As detailed in Chapter 2, Australia is facing a major demographic challenge.

With lower fertility rates and increasing life expectancy, the demographic profile of the nation is changing and the balance between the working-age population and others, including the retired, will shift dramatically.

Increased life expectancy will markedly lift the time that people spend in retirement. While in the 1900s, as shown in Chart 31, a man retiring at age 65 would have expected to spend 11 years in retirement, by 2050 this will have increased to 22 years, or, depending on ongoing improvements in health care,⁴⁴ may be as high as 28 years. Similar changes are forecast for women.

On a more contemporary basis, while a current male pensioner who, for example, retired in 1996 at the age of 65 years could have anticipated living until he was 81 years old, a man retiring at this age in 2050 can anticipate living until he is 87 to 93 years old. For women the increase is from age 85 to between age 91 and age 96.

Chart 31 Life expectancy at age 65

Source: Australian Government Actuary 2009.

At the same time:

There has been a trend towards early retirement and withdrawal from the workforce.
Increasing levels of educational participation, including time spent in higher education, has delayed entry into the workforce.

As a consequence, the actual proportion of people’s pre-retirement age spent in employment is reducing, and the time they spend in their retirement has increased dramatically. This has very significant implications for the retirement income system as a whole and for the Age Pension in particular.

For the pension system, it will result in increasing numbers of pensioners with life expectancies double or higher than was the case when the Age Pension age was originally set. The increase in life expectancy, especially if the higher projections are realised, will mean that superannuation savings will have to be spread more thinly to provide income for a longer period of retirement (and in all likelihood significantly increase the role of the Age Pension in meeting the longevity risk of these savings not ‘making the distance’).

It can also be expected that there will be pressure for an increase in the relative level of resources available to this group:

There are increasing expectations of higher living standards, to be sustained over longer, and in many cases healthier and more active, periods of retirement.
While some of the increase will be spent in good health, it is also likely that many in this older population will have significant health and related care needs, potentially over a longer period of their lives than today. This will bring with it a marked increase in demand for spending on health and related services.

As discussed in Chapter 2, Treasury forecasts in the Intergenerational Report 2007 indicate that the cost of an increasing number of pensioners and a growing life expectancy (while maintaining current pension settings) and increased age and health care costs will result in a rise in spending from 13.1 per cent of GDP to 18.2 per cent by 2046–47.

A change in the Age Pension age?

As discussed in Chapter 2, the Review considers that the long-term sustainability of the financing burden of the Age Pension is a serious issue. As well as the budgetary aspect, there are important questions concerning the societal support for the retirement system and the Age Pension. Without fundamental action such as a change in the Age Pension age, it is highly likely that there will be very strong pressure to restrain the value of the pension so as to minimise the growth in expenditure. This would in turn undermine the adequacy of future pension payments. More significantly, it is possible that the increasing funding burden may engender a reduced commitment of future workers to the support of the pension system.

In this context an increase in the Age Pension age is an option that needs to be seriously considered.

Specific benefits include:

An increase in the Age Pension age, and in the age of retirement, would partially redress the increasing dependency rate and concerns about a largely static workforce. Longer periods in employment would contribute to national levels of production and the tax base. For industry, it would provide extended access to an experienced workforce.
An increase would also enable individuals to experience the higher standards of living that are associated with employment for a longer period. It will boost their standard of living in retirement by reducing the span of time over which they draw down on their savings, including superannuation. It will also enable them to accumulate such savings over a longer period.
A reduction in demand on the Age Pension.

At the same time:

An increase in the Age Pension age represents a major cultural change and would require a substantial change in people’s expectations around their working lives.
A large proportion of people retire prior to the Age Pension age and a change in the age itself will not necessarily result in higher levels of participation.
Although average life expectancy is increasing, the actual pattern of mortality will mean that for some an increase in the Age Pension age may mean that they will not live long enough to retire, or will only have a short period in retirement.

On balance, the Review considers that the force of argument is clearly in favour of a modest rise in the age of eligibility for the Age Pension. In considering the magnitude of any increase the Review noted that taking account of the increase of some five to seven years in both male and female life expectancy between the 1970s and the early 2000s, and projected increases on a further three to seven years by 2050, suggests a total increase over this period of some nine to fifteen years.⁴⁵ In this context the Review considered that an increase in the Age Pension age of some two to four years would represent a reasonable balance in the distribution of this between work and retirement.

If these changes were built on the existing schedule for changing the Age Pension age for women, a pension age of 67 years would be reached in 2021, 68 years in 2025 or 69 years in 2029. It would be appropriate to consider the actual scheduling of any change in the context of changes to the broader retirement income system.

The impact of these changes would be marked. It is estimated that, for example, a three-year increase in the retirement age would have a similar effect as an increase of 2 per cent in the Superannuation Guarantee on the income replacement rates in retirement.

Challenges

Achieving these gains would, however, require much more than a simple change in the Age Pension age. There would also be a need for a broader package of measures and policies to support this shift, both removing incentives to earlier retirement and providing support for those who need it to enable them to maintain employment.

Central to this could be alignment of the preservation age with the Age Pension age. The Australia’s Future Tax System Review Panel is examining this and other issues impacting on participation as part of its broader review of the retirement income system. It will also be important that income support payments for people of working age, including the Disability Support Pension and Carer Payment, have a strong orientation towards supporting active participation, and that attention is paid to the training and retraining needs of older workers.

Achieving these changes will also involve a shift in expectations. Many people may build their expectations of their retirement age relatively early in their working lives, and so change will have long lead times.

Of people attending the public forums, 38 per cent submitted self-completion forms.
As at January 2009, under the income test, a single pensioner with no other private income can have up to $99,950 in financial assets, including bank accounts, prior to having their rate of pension reduced through the operation of the income test and deeming.
The Pension Loans Scheme is available to provide a top-up of the pension to people who receive a lower rate because of the operation of the assets test on such non-productive assets. The value of the loan is recovered from the estate of the pensioner. There are also special hardship provisions in the assets test.
This figure, however, has been somewhat boosted by a one-off influx of people who became newly eligible for pension when the assets taper was halved in September 2007.
This trade-off is another differentiation between participation incentives for age pensioners, and those on working age payments.
In this situation, while the pensioner would receive a net gain of $84.06 a week of pension income (excluding the value of bonuses) less income tax, a single non-pensioner employee would be paying $49.34 a week in income tax (including Medicare levy).
The effect of this ‘income deduction’ can be very significant. For example, in round terms, a man aged 65 with a superannuation asset of $100,000 could draw from this the equivalent to an inflation-adjusted annuity of around $7,000 over the following 18 years (the current life expectancy assumed in the pension system is actually 17.7 years). Offset against this would be an amount of $5,650 (100,000/17.7), giving assessable annual income of just $1,350. Since the first $3,588 of private income is ‘income test free’ this means, unless the person had other private income, with this $7,000 of income from superannuation they would still be entitled to a full pension.
Industry analysts estimate that there are currently more than 30,000 reverse mortgages in Australia, with an average value of around $60,000 for each mortgage (Hickey & Ling 2008).
Prior to the Disability Support Pension changes in 2006, assessment was based on an individual’s inability to work 30 hours or more a week. Under current assessment rules an individual must be unable to work 15 or more hours a week.
A key issue in estimating and projecting life expectancy of any current or future population is the impact of current population health and health behaviours and future health care on mortality. The chart contains three series provided by the Australian Government Actuary. For the period to 1995–97, the data are actual life expectancy, or estimated life expectancy based on current age-specific mortality. For the estimates beyond this point two series are available. The first, the 105-year projection, forecasts future mortality based on the rate of improvement in mortality over the past 105 years. The second assumes that the much more rapid improvement in mortality recorded over the past 25 years will continue.
Using ‘current’ mortality life expectancy at age 65 is estimated to have increased between 1970-72 and 2000-02 by 5.33 years for men and 5.06 years for women. Using the 105 year trend in mortality suggests an increase of 6.08 years and 6.16 years respectively, with these rising to 7.68 years and 7.56 years if the 25 year trend continues. The 105 year trend series suggests a further gain of 3.09 years for men and 3.67 years for women between 2001 and 2050. The 25 year trend series estimates the increases at 8.32 years and 6.88 years. Over the period from 1971 to 2050 this suggests an increase in life expectancy for men at age 65 at between 9.17 and 16.0 years and for women between 9.83 years and 14.44 years.

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