Income streams: social security income test (including defined benefits)

Since 1 January 2015, new account based pensions are assessed under the deeming rules that are applied to other financial products. Income received for the year is assessed by Centrelink as being a percentage of the account balance.

Current deeming rates (with working examples) are outlined under Means testing.

For pensions commenced before 1 January 2015 and long-term annuities, the income assessment is in most cases more favourable. Part of the payments received over the year are regarded as a return of capital and are exempt from assessment. The portion of income assessed is determined by reducing the actual income received by a deductible amount.

The deductible amount is equal to the purchase price, less commutations divided by the relevant number which is the term of the pension, or where that isn’t known, the life expectancy of the primary or reversionary beneficiary, whichever is greater.

The deductible amount represents the pension payments which are a return of capital. The deductible amount will not change over the life of the pension unless a lump sum commutation is made. In this case, a new deductible amount is calculated by first reducing the original purchase price by the lump sum commutations, before dividing by the relevant number which will be the original relevant number determined at commencement.

Short term annuities are income streams with a term of five years or less, except where the term reflects life expectancy. They are assessed under the deeming rules.

For defined benefit pensions where there is no purchase price, the deductible amount is taken to be the tax free component (if any) of the pension payments. Since 1 January 2016 the deductible amount has been capped at 10 per cent of the pension payments, excluding those sourced from some military superannuation funds.

Example

Mary has commenced a defined pension payable from a non-military taxed public sector fund. Her pension payments contain a 30 per cent tax free component representing the after tax contributions she made to the fund over her employment. When Mary applies for the Age Pension under the income test, 90 per cent of her annual pension payments will be assessed. 

For lifetime income streams purchased after 1 July 2019, 60 per cent of the gross payments are assessed as income.

Details of the income test assessment of account based pensions and the grandfathering provisions can be accessed in the Social Security Guide.

If the Centrelink payment ceases (even if only temporarily, e.g. if your client is overseas beyond the allowed period) the grandfathering will be lost and the income subject to the deeming rules.

Lifetime and long-term fixed term annuities are not affected by the deeming treatment of account based pensions that commenced from 1 January 2015.

Further details of the income test assessment and extension of the deeming provisions since 1 January 2015 can also be found in the Social Security Guide.