Chapter 01 – Pensions as a low-risk investment asset

For a single person, the full aged pension in Australia, with all entitlements, is currently worth $894 per fortnight. This equates to $23,244 per annum. A couple receives $1348 per fortnight, or $35,048 per year. (please note these figures are indexed and will grow slowly over time). 

What does this income stream equate to in terms of a lump sum?

There are various ways to calculate the value of a pension as a lump sum. One is to equate the pension – which is a guaranteed payment from the lowest risk provider of payments available, the Commonwealth government – to interest on a low risk investment such as a cash management account or a term deposit. For a 12-month term deposit, the average interest rate payable on a larger amount deposited is currently 2.4%. An individual would need to hold $968,500 in an investment paying 2.4% to generate annual income of $23,244 per year. A couple would need to hold $1,460,333 in such an investment to generate income of $35,048 per year.

Using a term deposit as a point of comparison, this means that the aged pension is the equivalent to almost $1 million ‘in the bank’ for an individual, and almost $1.5 million in the bank for a couple.

Another way to calculate the value of a pension is to calculate the present value of the income stream represented by that pension. The current age threshold for an aged pension is 65. The Australian government actuary reports that a woman aged 65 can expect to live another 22 years. Men can expect to live slightly less than this. If we average this out, we could assume that a person commencing on the aged pension will probably receive that pension for the next 20 years.

Using the interest rate of 2.4%, the present value formula suggests that we should multiply the current year’s pension receipt by a factor of 15.74 to calculate the present value of a twenty-year income stream. For a 65 year old individual, this becomes $365,860. For a couple of the same age, it becomes $551,655.

Either way, eligibility for a Centrelink pension is analogous to holding a substantial, conservatively-invested personal asset.

Pension eligibility as a personal asset when allocating assets

Some advisers use the pension as a ‘shadow asset’ when calculating a client’s net asset position. What’s more, they include that ‘shadow asset’ as a defensive asset when thinking about a client’s risk profile. This can be best demonstrated with an example.

Nav and Jacinta are 66 years old. They own their home, worth $650,000, and have a joint $200,000 in superannuation. They ask their adviser’s opinion about how best to invest that $200,000 – should they opt for high growth, or should they invest it more defensively now that they are retired? Their friends all say it should be largely defensive, as does the ‘conventional wisdom’ within financial planning. After all, at their time of life, they can no longer generate employment income. 

Their adviser has a different approach. She lists their non-home personal assets as follows:

Asset type Growth/Defensive Value % of total
Centrelink pensions Defensive $551,655 73%
Superannuation To be decided $200,000 27%
Total non-home assets   $751,655 100%

Using this analysis, the adviser reckons that this couple currently hold 73% of their total non-home assets in defensive assets. Given their ages, she expects that at least one of them will live for another 20 years. Therefore, their wealth needs to last at least that long. Accordingly, the advisor is concerned that the total assets should not be invested too conservatively. Accordingly, she recommends that the superannuation funds be held in ‘high growth’ mode within their particular superannuation fund.

While other advisers may disagree with this approach, the logic makes good sense. The couple are in receipt of a pension from the most secure source of income in Australia: the Commonwealth government. That income stream is as secure as possible. It is also indexed at least to inflation.

With 20 years or more to live, placing 100% of their superannuation assets in a defensive portfolio runs the risk of a substantial reduction in purchasing power over time. The certainty of the pension income means that short-term fluctuations in the market value of their superannuation will not become consolidated by a need to withdraw substantial superannuation funds at that time. The couple will have a substantial amount of control over the timing of any withdrawals from superannuation.

The pension is effectively an annuity

As the above analysis makes clear, eligibility for the aged pension is basically the same as holding an annuity. As with an annuity, the recipient will receive a designated amount of cash for the remainder of their life. Because the aged pension is effectively an annuity, Dover tends to dislike seeing Centrelink recipients purchasing their own annuities – sometimes even displacing the existing annuity (that is, the Centrelink pension).

You can read a practice note on annuities here – it was first published in February 2017.

This is one area where ‘financial planning 101’ (which often states that older people should skew their investments towards defensive assets) might not be in a client’s best interests. 

The Dover Group