Maria and Carlos’s dilemma
How will an inheritance affect your Age Pension entitlements? Many Retirement Essentials readers ask this question. As life expectancy increases, it’s not unusual for people to receive an inheritance much later in life—often when they are already retired and receiving an Age Pension.
If you do receive a lump sum inheritance (or any lump sum), there are some important things you need to know to avoid unexpected pension reductions or even overpayments that need to be repaid.
You must tell Centrelink
It’s essential to notify Centrelink within 14 days of receiving any lump sum. Failing to do so can result in overpayments that must be repaid, which can be difficult if the funds have already been spent.
Maria and Carlos’s inheritance dilemma
Maria, 70, and Carlos, 75, received a $400,000 inheritance. They own their own home with a $180,000 mortgage and have $470,000 in combined super. They also like to keep a cash buffer of $15,000 for emergencies, and value their personal assets at $25,000.
Currently they are receiving $41,735 in Age Pension as a couple, and they draw down their additional spending needs from their Account-Based Pensions.
Their top three questions were:
- Would gifting inheritance money to their children affect their pension?
- Should they pay off their mortgage?
- What’s the best way to use the money without losing Age Pension benefits?
How Centrelink assesses an inheritance
If you redirect the inheritance to someone else, then Centrelink considers this gifting.
Centrelink treats an inheritance as a gift and applies the assets and income test to this money to determine eligibility for the Age Pension. How you use the inheritance matters and can affect the calculation.
Paying off the mortgage or renovating
If you use your inheritance to pay off your mortgage, it will not affect your Age Pension because your home is exempt from the assets test. For Maria and Carlos, paying down their mortgage was an attractive option, as it would reduce their debt without affecting their pension.
Saving or investing the money
If you deposit the inheritance in a bank account or invest it, Centrelink will count the whole amount in the assets test and will also apply the deeming rules. This means Centrelink assumes the funds are earning a set amount of income and includes the deemed income in the income test.
For example, if Maria and Carlos deposited the $400,000 into a savings account or invested in term deposits, Centrelink would deem the funds to earn $9,000 annually. Since their combined income exceeds the $9,672 per year threshold, their fortnightly payments would be reduced by 50 cents for every $1 over the threshold, according to the income test.
Under the assets test, their Age Pension would be reduced by $3 per fortnight for every $1,000 their assets exceed the threshold. Prior to receiving the inheritance, Maria and Carlos’s assets were just above the lower asset threshold of $470,000 as a homeowner couple, allowing them to receive close to the full Age Pension.
In this case, the additional $400,000 could reduce Maria and Carlos’s Age Pension by up to $31,200 annually under the asset test. Whichever of the tests – the assets or the income test – results in the lower pension entitlement will determine their eligibility.
Gifting to their children
Centrelink allows couples to gift up to $10,000 per financial year, with a total of $30,000 allowed over 5 years. Any gifts above these limits are still considered assets for five years and will affect the Age Pension. For Maria and Carlos, they planned to gift $50,000 to their two children, but only $30,000 would be within the allowable limits.
Contributing to super: eligibility and benefits
One of the key decisions Maria and Carlos considered was contributing to superannuation. Super can be a tax-effective place to invest, but there are rules to consider.
Age limits: Non-concessional contributions (NCCs) can be made up until age 75, and (at age 70) Maria does not need to meet the work test for these contributions.
Contribution caps: The annual NCC cap is $120,000, but as Maria’s total super balance is below $1.9 million, she may be able to use the bring-forward rule to contribute up to $360,000 over three years.
Super accumulation vs. pension phase: Once in super, the money can remain in the accumulation phase or be converted to an Account-Based Pension, which offers tax-free investment earnings and flexible withdrawals.
What’s the best strategy?
After considering their options, Maria and Carlos decided on the following strategies to balance their financial goals and optimise their Age Pension entitlements:
- Pay off their mortgage: Using part of their inheritance to completely pay off their mortgage was a top priority. Since their home is exempt from the assets test, paying down the mortgage didn’t affect their entitlements.
- Future proofing: Setting aside $50,000 of the money to spend on home renovations and a new car, as these would not affect their entitlements. It will also make life easier in the home they love.
- Gift $10,000 per financial year to their children: By gifting $10,000 each year over the next three years to stay within Centrelink’s rules. Then, after 5 years from 2030, they can gift $10,000 per financial year for two more years.
- Contribute $120,000 to Maria’s superannuation: One of the most strategic moves was contributing $120,000 to Maria’s superannuation. Since non-concessional contributions are allowed for people under 75, this was a good opportunity for Maria to invest the inheritance in a tax-effective environment. The combined balance of her existing and new superannuation can then be transferred into an Account-Based Pension for ongoing retirement income.
By structuring their inheritance carefully, they were able to achieve multiple financial goals:
- Maintaining a safe level of spending: Forecasting shows that this strategy would allow them to sustainably spend $75,000 per year through to age 95 without being likely to run out of funds.
- Preserving their Age Pension: Instead of losing an estimated $31,200 in Age Pension entitlements, they optimised their assets to remain eligible for approximately $28,865 per year, and support their desired level of spending using drawdowns from their increased superannuation savings.
- Becoming mortgage-free: This reduced their ongoing living costs and provided peace of mind.
- Gifting to their children within Centrelink’s rules: By spreading out their gifts over time, they stayed within allowable limits while still helping their family.
- Investing tax-effectively: Contributing the funds into superannuation and then using Account-Based Pensions for ongoing income needs, provided a more tax-efficient way to invest compared to holding the money in cash or other taxable investments.
Check how an inheritance might affect you
If you have received an inheritance or think you might in the future, you can use the Retirement Essentials eligibility calculator to see how this could affect your entitlements.
Need help with your inheritance planning?
Every situation is unique, and the right strategy depends on your personal goals and financial circumstances. If you’d like tailored guidance on how to maximise your entitlements, invest tax-effectively, and structure your inheritance to support your retirement lifestyle, why not book a one-on-one strategy consultation with one of our experienced advisers?.
We also love to hear from you. Let us know your thoughts by commenting below.
Have you or someone you know received an inheritance while on the Age Pension? How did you decide what to do with it?
If you received a lump sum inheritance today, what would be your top priority – paying off debt, investing, or something else?
This article is provided by Retirement Essentials Representative Number: 001260855. We are an authorised representative of SuperEd Pty Ltd ABN 88 118 480 907 AFSL #468859. This information is not intended as financial product advice, legal advice or taxation advice. It does not take into account your personal situation, goals or needs and you should assess your own financial situation, consider if the information is suitable for you and ensure you read the relevant Product Disclosure Statement (PDS) if you choose to make any changes to your financial situation. It is always advisable to consult a financial adviser before making financial decisions.
