Assessment of Policy Changes to Means-Tested Age Pension Using Expected Utility Model: Implication for Decisions in Retirement
21 Pages Posted: 5 Jun 2017 Last revised: 15 Sep 2017
Date Written: July 7, 2017
Means-tested pension policies are typical for many countries and are very important to the pension system. These policies are specific for each country, and the assessment of policy changes is critical for policy makers. In this paper we consider the Australian means-tested Age Pension. The Australian Government uses the means-test as a way of managing the pension budget. Changes in Age Pension policy impose difficulties in retirement modelling due to policy risk, but any major changes tend to be ‘grandfathered’ meaning that current retirees are exempt from the new changes. In 2015, two important changes were made in regard to allocated pension accounts: the income means-test is now based on deemed income rather than account withdrawals, and the income-test deduction no longer applies. We examine the implications of the new changes in regard to optimal decisions for consumption, investment, and housing. We account for regulatory minimum withdrawal rules that are imposed by regulations on allocated pension accounts, as well as the 2017 asset-test rebalancing. The new policy changes are modelled in a utility maximising lifecycle model solved as an optimal stochastic control problem. We find that the new rules decrease the benefits from planning the consumption in relation to the means-test, while risky asset allocation becomes more sensitive to the asset-test and the housing allocation increases slightly in order to receive additional Age Pension. The difference in optimal drawdown between the old and new policy is only noticeable early in retirement until regulatory minimum withdrawal rates are enforced. However, the amount of extra Age Pension received for many households is now significantly higher due to the new deeming income rules, which benefit slightly wealthier households who previously would not have received Age Pension due to the income-test and minimum withdrawals.
Keywords: Dynamic Programming, Stochastic Control, Optimal Policy, Retirement, Means-Tested Age Pension, Defined Contribution Pension
JEL Classification: D14, D91, G11, C61
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