Social Security Rules
Most investments are subject to means testing arrangements for social security pensions and allowances and Veterans' Affairs pensions.
Retirement income streams are no different and they are subject to means testing. However, they have their own specific rules for both the income and assets tests.
For the income test, special rules are applied to most income streams because the income stream payments you receive will generally include a return of part of your capital. So there needs to be a way of working out which bit is income and which is your capital. Generally, for the income test, it is only the income part which is counted under the income test.
For the assets test, all income streams are counted in some way except one category which receives a partial assets test exemption. As a general rule, only those income streams where your capital cannot be accessed receive a part exemption from the assets test.
Categories of Income Streams
The treatment of your income streams under the income and assets tests will differ depending upon:
- the characteristics of the income stream; and
- the duration over which income (and capital) is designed to be paid; and
- your age at the time of commencing the income stream.
What this means in practice is that income streams will be treated according to their features under social security rules. Income streams are classified into three separate categories for social security purposes as shown in the following table.
| Short Term Assets Tested | Characteristics:
All income streams which are not Category 2 or 3 income streams (generally income streams of a fixed term of 5 years or less). |
Income stream types included in this category
|
| Long Term Assets Tested | Characteristics:
Income streams that are payable for a fixed term in excess of 5 years, and all other income streams that do not meet the specific requirements of Category 3. |
Income streams included in this category :
|
| Long Term Partially Assets Test Exempt | Characteristics:
All non account based lifetime income streams that meet the general conditions below. Certain fixed term income streams that meet the following conditions as well as the general conditions below:
For market linked income streams, the income payments must be at least the annually determined minimum level. General conditions All Category 3 income streams must meet a number of conditions. The main ones are listed here. The income stream must:
There are other characteristics that must be met (particularly if your income stream can be paid to another person on your death) and you should seek further information about this. |
Income stream types included in this category
|
The partially assets test exempt category of income streams will cease from 20 September 2007, meaning that there will not be any income streams purchased after that date that will benefits from a full or partial assets test exemption.
For certain income streams purchased prior to 20 September 2004, different rules applied and complying income streams received more generous assets test treatment than is currently the case.
How do the 'life expectancy' rules work in practice for income streams purchased before 20 September 2007?
To qualify as a complying income stream and hence receive more favourable assets test treatment, certain fixed term and market linked income streams must at least be payable for a term which is broadly equal to the life expectancy of the purchaser (rounded up to the nearest whole year). As we have seen there are other circumstances where the term can be up to the number of years to age 100. To illustrate this let's have a look at a couple of cases.
| Joe is age 72 and has an average life expectancy of 12.75. If he purchased a life expectancy income stream with no residual value that met the other conditions for a complying income stream, 50% of Joe's income stream value would be exempt from the assets test. |
| Elizabeth is aged 63 and has an average life expectancy of 22.85 years. If she purchased a market linked income stream with a term of at least 23 years and it met the other conditions for a complying income stream, 50% of Elizabeth's income stream value would be exempt from the assets test. |
Bill is aged 66 and his spouse Julia is age 64. His life expectancy is 16.95 years and hers is 22 years. If they purchased a market linked income stream that:
|
What are the means testing rules?
The following table shows how each of the 3 categories of income streams are generally assessed for determining the income for the income test, and the asset value for the assets test.
| Category | Income Test Rules | Assets Test Rules |
|---|---|---|
| Short Term Assets Tested | Subject to 'Deeming' and the deemed income is based on the assets test value (see below for 'deeming' rules). | Assets tested and there is a formula for working out the asset value (see below for details). |
| Long Term Assets Tested | The income stream payment is assessed but it is reduced by an amount of 'exempt income' (see below for details). | This category is assets tested.
Where the income stream is account based it is the investment account balance which is counted. In any other case there is a formula for working out the asset value (see below for details). |
| Long Term Partially Assets Test Exempt | The income stream payment is assessed but it is reduced by an amount of 'exempt income' (see below for details). | This category receives a 50% assets test exemption provided it is purchased prior to 20 September 2007.
In some cases, a 100% assets test exemption applies for complying income streams purchased prior to 20 September 2004. |
How to work out the income and assets test values
Working out values for the income test
For category 2 and 3 income streams, the income stream payments will be treated as income. However part of that income will be exempt from the income test. To work out how much of the annual payment from the income stream will be assessed for social security purposes, use the following formula:
For category 2 income streams:
Annual Payment less [(Purchase Price - RCV) ÷ Relevant Number]
For category 3 income streams:
Annual Payment less [Purchase Price ÷ Relevant Number]
The relevant number is:
- For an income stream payable for a fixed number of years, that number of years.
- In all other cases the longest life expectancy of either the investor and/or the reversionary beneficiary (where specifically nominated).
Where an income stream is purchased on the basis that the income may be payable to a spouse or other person, or the investment is made jointly, the longest life expectancy (per the tables referred to earlier) of the couple is used in this calculation.
Note that the Purchase Price will be reduced by the total amount of any lump sum commutations made at any stage after commencement.
Defined Benefit Pensions
Defined benefit pensions have their own special income test calculations. The assessable income amount is calculated as:
Annual Payment less Deductible Amount (which is defined as per relevant tax calculations)
From 1 July 2007, the formula used to calculate deductible amount will change for new income streams and also for existing income streams when the recipient turns age 60. However, this method will still be used to assess the amount of income on an ongoing basis at any age.
| Category 2 Income Stream
Alfonso is 66 years of age. He is single and has an average life expectancy of 16.9years. He invests $100,000 in an allocated income stream and he receives an incomeof $8,000 in the first year. When he works out his income for the income test he dothe following calculation: $8,000 - $100,000 ÷16.95 = $2,101 16.95 This means that of his $8,000 income payment, $2,101 is counted as income under the income test. If Alfonso invested in a 10 year fixed term income stream, which had no cash back at the end of the term (ie no residual value) and income payments of $13,500, he would work out his income as follows: $13,500 - $100,000 ÷10.00 = $3,500 10.00 This means that of his $13,500 income payment, $3,500 is counted as income under the income test. |
Working out values for the assets test
For those non account based income streams which are subject to the assets test, there is a formula for working out an asset value. The reason there is a formula is because there is no clearly identifiable asset value once the income stream has been purchased and hence one needs to be calculated.
For account based income streams there is no need to work the asset value as this value will be the investment account balance.
To work out the asset value during the period of the income stream the following formula applies.
Purchase Price - [ [ (Purchase Price - RCV) ÷ Relevant Number] x Term Elapsed ]
The term elapsed is the number of years that have elapsed since the income stream commenced. In most cases the asset value is reduced six monthly in arrears (which means that the asset value equals the purchase price for the first 6 months). However, where the income payments are annual, the asset value decreases annually in arrears.
For lifetime income streams, this formula means that there will be no assessable asset value once the income has been paid for a term at least equal to the appropriate life expectancy of the person (or couple).
Defined Benefit Pensions
Defined benefit pensions have their own formula to calculate the amount of assessable asset values each year. In some cases, some of all of the asset value may be exempt where the defined benefit pension meets all of the required criteria to be a 'complying' pension for social security purposes.
| Category 2 Income Stream
Take Alfonso from the previous example. He invested $100,000 in a 10 year fixed term income stream. We'll assume he receives his income payments monthly. After 6 months has passed Alfonso has his income stream assessed under the assets test. At that time the calculation of the asset value will be:
So for the second six months his asset value for the assets test will be $95,000. This figure will reduce every 6 months thereafter for the 10 year period. |
Impact of 'deeming' for short term income streams
Under the income test, those income streams which are classified as short term (ie. 'category 1' income streams) will have their asset value (as calculated above) subject to the deeming rules. This means that 'deemed' income is assessed for the income stream. The actual income is not counted.
Under deeming, the values of all of your 'financial investments' are added together. Income on the total value is assessed at the rates in the table below. The actual income from these investments is not assessed. Financial investments include bank, building society and credit union deposits, cash, shares, fixed interest investments, managed investments and category 1 income streams.
Deeming rates are adjusted from time to time. The rates which apply at 1 July 2007 to financial investments, including short term category 1 income streams are:
| Deeming Rate | Deeming Rate Threshold |
|---|---|
| 3.5% | Up to $39,400 |
| 5.5% | Excess over $39,400 |
| Deeming Rate | Deeming Rate Threshold |
|---|---|
| 3.5% | Up to $65,400 |
| 5.5% | Excess over $65,400 |
*These rates are subject to review by the Minister for Families, Community Services and Indigenous Affairs and may be varied from time to time.
Need more information about social security?
While this information contains a general outline of the social security rules, it does not include all of their details. If you need more information about social security rules, you could seek further information from a Centrelink Financial Information Service Officer.