Interaction Between Age Pension Means Testing and Innovative Income Streams in Australia*

Abstract

We investigate the interaction between Age Pension means testing and innovative income streams in Australia, considering the use of an investment-linked annuity that allows a choice of drawdown level. We find that current means testing arrangements incentivise a very specific usage of investment-linked annuities that is not materially impacted by individual characteristics or fees, due to incoherencies across the income test and assets test. We investigate alternative means test structures, including a structure that includes only an income test and incorporates capital consumption by adjusting taper rates with age according to an annuitisation schedule. This structure removes the distortions impacting annuity usage, generates the most stable Age Pension over lifetime, encourages drawdown of assets over retirement and more accurately reflects the means of retirees to generate an income at each age.