As our population ages, it’s becoming increasingly common to see retirees with account-based pensions being paid to them from their superannuation fund. One of the attractions of these types of pensions is the flexibility that they provide.
More specifically, they provide retirees with the ability to increase the level of income received, or instead, to take additional lump sum amounts when required. When combined with the tax-free status of these payments for people aged over 60, it isn’t hard to see why they are so attractive.
The sting
Interestingly though, the way in which additional money is taken from a pension could come with a sting in the tail if the retiree is also a Centrelink pensioner.
In short, when applying an income test assessment of these pensions, Centrelink recognises that some of the amounts received by a retiree are actually a return of that person’s capital – this amount is aptly referred to as a non-assessable amount by Centrelink. As such, it’s only in situations where a retiree receives pension income that exceeds this non-assessable amount that any income will be assessed under the Centrelink income test.
Also, additional lump sum withdrawals are not assessed as income. So, when requesting additional money from a pension, some retirees may choose to take these amounts from their pension as a lump sum withdrawal rather than as a pension payment.
However, a potential trap lies in the way that a retiree’s non-assessable amount is calculated.
That’s because each time a lump sum withdrawal is made (often referred to as a commutation), the non-assessable amount is reduced – and in time, particularly if regular withdrawals are made, this could lead to adverse Centrelink outcomes.
Fortunately though, in many cases, retirees will be receiving regular pension amounts that are less than their non-assessable income portion. And in these cases, it could be advantageous to maximise their income-free limit before treating amounts as lump sums.
For example:
David is 65 and started a pension two years ago using his superannuation, which was worth $250,000 at the time. He has also been receiving an Age Pension from Centrelink.
He currently receives a regular superannuation pension of $10,000 a year and his pension account balance has fallen to $200,000.
Based on his circumstances at the time, Centrelink determined that the non-assessable income from this superannuation pension is $15,423 a year. As such, none of his annual pension income has been assessed because it falls below this amount, and as he is aged over 60, the withdrawals have been completely tax-free!
However, this year David will need an extra $5,000 to pay for a holiday.
Option 1: lump sum
Now David could withdraw this entire $5,000 as a lump sum commutation amount and pay for his holiday, and because it is a lump sum withdrawal, none of it would be assessed. However, the withdrawal would cause his ongoing non-assessable portion to be permanently reduced to $15,114 a year.
While this will not be immediately problematic, it may result in more pension income being counted by Centrelink in future years – particularly if David continues to reduce his non-assessable amount by making further lump sum withdrawals.
Option 2: additional income payment
On the other hand, David could have chosen to take the entire $5,000 as an additional income payment. As this amount would not have exceeded his non-assessable amount for the year ($10,000 pension + $5,000 additional payment = $15,000, which is below his original non-assessable amount of $15,423), none of it would be assessed. But more importantly, his existing non-assessable amount would be protected.
What should you do?
It’s important to find out what the impact of any additional withdrawal – lump sum or additional income – will have on your non-assessable amount so that you can work out the longer-term impact of your decision.
In many cases, it will be best to have some of the additional withdrawal amount treated as additional income payments and some of it treated as a commutation.
So, what would seemingly appear to be a simple question on a Centrelink information request form, could lead to longer-term negative impacts for many retirees that can be easily avoided with some careful planning.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
