I made a calculation today that shocked me.

It appears that there is a serious conflict between the Australian pension system and the Australian superannuation system. One promises to pay out a good amount of TAX-FREE money after age 67. The other motivates you to save (through tax benefits) so that you can presumably get a "higher" level of income in old age without needing to access the age pension.

But why would anyone (particularly an economist) reject the offer of free money? The current age pension (free lunch) is $29,354 which is equivalent to someone having saved around $587,080 (I'm using a 5 per cent return for simplicity). That's a LOT of free money being offered by the Australian government with virtually no conditions attached.

Never refuse a free lunch, as they say. Particularly lunch that comes without fine print.

I worked out the level of superannuation (or other) savings that I must aim for to maximise my free lunch. My results (spreadsheet) are posted below.

My calculations show that I'd be a fool to save "too much". If I save anything more than, say, $277,000 in superannuation, I'd start losing the age pension (after age 67) at a frightening rate. I'd not only be paying a tax of 15 per cent today while contributing to superannuation, but when I withdraw the money in the future (supposedly as a tax-free annuity) I'd get the "pleasure" of paying an effective marginal tax rate of well over 50 per cent!

Proof

If I increase my superannuation savings to, say, $297,280, i.e. by 7.2 per cent, then my total income (including age pension) would increase by only 1.2 per cent (from $42,968 to $43,468 per annum).

I've concluded that it is a fool's errand to save more than $277,000 (approximately) in superannuation in Australia. 

This is therefore (roughly) the "optimal" savings target for a couple in Australia (this amount should ideally be kept in a super fund, it being tax sheltered – thus getting a double free lunch!).

Everything else over and above this (and I mean everything else!) should be SPLURGED before reaching 67.

If I splurge today, the taxpayers of tomorrow have promised to pay me GOOD MONEY till I die! Nice! I'm glad I've discovered the ONE FREE LUNCH in this life. The laws of economics have been broken by Australia. Well done! All's well with the world – for now; at least for me! (As Keynes said, in the long run we are all dead. And I'm not one to complain while Australia promises to feed me right up to my death in old age.)

Since I've already exceeded this amount of savings in superannuation (and I'm 15 years away from the age pension) I must now demolish my house and build a fancy 5-star facility, instead. The less I own in cash and the more I own in my house (which is exempt from the assets test! beauty!) the more profitable is the Australian magic pudding.

So why do I publish this "dirty" secret?

First, to be proven wrong. If my calculations are wrong, then I'll be making a big mistake by demolishing my house and building a 5-star facility.

Second, if I'm right then I hope this will prompt the fools ("policy" gurus, they are called) who have created a scheme by which calculative baby boomers (like me) will take Australia to the cleaners.

Now, I must, in all honesty, also offer good advice, since I'm not really in favour of Keynesian free lunches.

There are many ways to fix this SERIOUSLY BAD POLICY. Best solution: Get rid of the pension system completely. Of course, that will be hard (politically). 

If no one has the guts to abolish the pension that then at least reduce the pension significantly and also reduce the 50 per cent marginal reduction of pension with every extra dollar earned to, say, 15 per cent. This will make it worthwhile for people like me to save for their future.

Such solutions (and there are an infinity of combinations possible) will protect future taxpayers in Australia from a Greece-like situation in which they feed and clothe baby boomers like me who will have fun in their 5-star homes (maybe by then I'll have installed GOLD BATHROOM FITTINGS!) while young Australians work their bottoms off to pay a mountain of debt!

I'm also providing the underlying Excel spreadsheet.

Addendum

The internet (even newspapers) are flooded with useful advice (on how to rip off the Australian taxpayer). Here's one example:

This person has $150,000 in super at the time of starting age pension (gives appx. $15k in pension – optimistically). The assets test for a married home-owning couple is $258,000. As long as the rest of your assets, including cars, investments, house contents and any other assets, do not have a total value of more than $108,000 (not 118) you will get the full pension under the assets test. [Lesson: DON'T buy fancy car/s. Don't buy unnecessary shares. Simply put everything into bathroom fittings and marble tiles.]

 

Under the income test, the full value of the $15,000 superannuation pension will not be counted. For the income test, this pension is reduced by its purchase price. This is calculated by dividing the value of your superannuation at the time of starting the pension by your life expectancy. According to the life-expectancy tables, a man aged 65 has a life expectancy of 18.54 years and a woman a life expectancy of 21.62 years. This would result in an annual purchase price on super of $150,000 of $8091 for a man and $6938 for a woman. The fortnightly pension income counted by Centrelink would be $266 for the man and $310 for the woman.

 

Under the income test, a couple can earn up to $256 a fortnight and still receive the full age pension. In addition, income earned on other financial assets, calculated under the deeming provisions, will be added to this net pension income. For every dollar your total income exceeds the $256 threshold, the age pension will be decreased by 50¢. Assuming you had deemed income of $20 a fortnight, if you wanted to receive the full age pension, the superannuation pension would need to be $13,700 a year for a man and $12,550 for a woman.

 

Basically you can get a good amount of money ABOVE full age pension in old age by keeping your assets and financial investments low. So take it easy and relax. Build a mega-mansion. And don't forget to take a lot of foreign holidays. SPLURGE.

LUMP SUM WITHDRAWAL FROM SUPER

Strategy: Take the benefits of tax shelter for salary sacrifice till you can. Pay a minimal amount to the mortgage, then retire one month before age 67, and encash the entire super as lumpsum. [if you retire from the workforce after age 55 you may receive superannuation benefits via either lump sum or pension payments.] Make sure you split income with spouse, to ensure you remain well below the $500K threshold and are able to contribute 50K through salary sacrifice.

With regards to lump sum payments, the first $140,000 of the concessional component may be received free of tax with the balance taxable at 16.5%. [Source]

Q. Is there any way I can use superannuation to help pay off my mortgage?

A. Yes, this is possible for persons aged 55 and over who access a Transition to Retirement (TTR) pension. A TTR pension is available to those aged 55 and over who are still working. Essentially, it is an account-based pension that does not permit cash withdrawals, but allows access to superannuation money in the form of an income stream. The amount of income that can be drawn is generally between 4 per cent and up to a maximum of 10 per cent of the superannuation account balance at 1 July each year. Therefore, you can use the income stream to help increase your mortgage repayments and repay your mortgage quicker. But you need to weight up your options and do the numbers on this strategy as you may be reducing your retirement benefits. [Source]

From the Westpac Bank super booklet.

You’re supposed to pay off your mortgage first, then hurriedly put money into super before you retire, right? Not necessarily. You no longer need to pay tax on super withdrawals once you turn 60. That means doing it the other way around could see you boost your super savings substantially and pay off your mortgage by the time you retire. Who does this suit? 

This strategy works best if you: 

• Are on one of the higher marginal tax rates. 
• Have an outstanding mortgage [in my case I will CREATE a new mortgage] and are looking to boost your super savings. 
• Are close to retirement (e. g. 5–10 years away) and will not need to access the money you are putting into super. 
• Plan to retire at age 60 or over.

It works like this:

If you’re currently paying Principal and Interest on your mortgage, the idea is to switch to Interest Only repayments for some or all of your loan. That way, your repayments will drop, leaving you with money that can be redirected into your super. You  can put before-tax dollars into super by salary sacrificing. Remember, you make home loan repayments from after-tax dollars.

So let’s say your mortgage repayments drop $1,000 per month and your marginal tax rate is 38.5% (including Medicare levy); you can salary sacrifice $1,626 each month and your take-home salary will still be roughly the same. The money that usually goes towards your mortgage is only taxed at 15% when it goes into super. So, in the example above, instead of paying $626 to the government in tax, you’re only paying $244. That extra $382 is going straight into your personal super.  

When you retire at 60 or over, you then pay off your mortgage from your super fund. Under the previous rules, you would have generally paid lump sum tax on the amount you withdrew from super. With the new rules, you can do this without paying any tax on the lump sum.