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'Deeming' debate here to stay: what it means for you

Emma Rapaport  |  16 Jul 2019Text size  Decrease  Increase  |  
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It's been a turbulent year for Australian pensioners. First, they faced an attack on their franking credits, then market volatility eroded their returns, and now the dramatic fall in interest rates is depriving them of their age pension entitlements.

The Reserve Bank of Australia's steady lowering of the cash rate may be good for borrowers, but at the same time it's undercutting the so-called "deeming rate" – or the amount pensioners are assumed to earn from their investments.

The RBA slashed the official interest rate in July for the second time in as many months to a record low 1 per cent. At the same time, the deeming rate has remained stagnant.

Even before the franking credit issue – or "retiree tax" – blew up, aged care advocates were warning that deeming rates were punishing pensioners.

"If a deemed rate is higher than an actual rate, the pensioner loses out," aged-care consultant John Rawling wrote in February last year.

This week, the Morrison government buckled to pressure from advocacy groups by slashing deeming rates:

  • The deeming rate for large investments has fallen from 3.25 per cent to 3 per cent;
  • and for smaller ones from 1.75 per cent all the way down to 1 per cent, backdated to the start of July

But seniors and retiree groups say the rate cut doesn't go far enough.

Another rate cut is expected before Christmas, which has thrust the deeming debate even further into the foreground.

By 2057, it is projected there will be 8.8 million older people in Australia. Considering this changing demographic, deeming will only become more important. In this article, we examine:

  • Deeming and its origins
  • How the recent changes may affect you
  • And how deeming relates to cash rate set by the RBA

What is deeming?

Australian pensioners have some of their retirement savings invested in financial products such as term deposits, cash (savings accounts), listed shares and managed funds. From those investments they receive a return.

To be eligible for the age pension, retirees (over 66) must pass two means-based tests – the assets test and the income test. The test that pays the lower rate of pension is the one that applies.

  • The assets test is applied first. It calculates a person's assessable assets (excluding the family home), determines the threshold ($394,500 for a homeowner couple; $263,250 for a single homeowner), and works out if their assets exceed the threshold. If they're not, the test then calculates the maximum pension less any reductions.
  • Then, the income test is applied. This is where deeming comes in. For simplicity, instead of using actual returns from financial assets, Centrelink uses deeming to determine income flowing from assets. Financial assets are assumed to earn a certain level of income, regardless of the actual income received from an investment. The deeming rate applies at two levels: financial assets up to (today) $51,800 (single) $86,200 (couple) are deemed to return 1 per cent, while assets above these thresholds are deemed to return 3 per cent.

Deemed income test:

Retired couple Dave and Sue have financial investments of $400,000, comprising: bank account $100,000 and super (accumulation) $300,000.

To calculate assessable income under the income test:

  • $400,000 (deemable assets) - $86,200 (financial asset value for deeming) = $313,800
  • $313,800 x 3.25% (higher deeming rate) = $10,198.5

Plus

  • $86,200 x 1.75% (lower deeming rate) = $1,508.5
  • $10,098.5 + $1,508.5 = $11,707 pa

Deeming: a Hawke-Keating legacy

Deeming was introduced for age pension eligibility by the Hawke/Keating Labor government in 1990. The policy grew out of fears that pensioners were parking their money in low-interest bank accounts in order to qualify for the pension.

"Pensioners were putting all their savings into chequing accounts – accounts that paid no interest – so they would feel no impact to age pension eligibility," Louise Biti, director of Aged Care Steps says.

And as Australian National University visiting fellow Peter Martin notes in The Conversation, "It cost many of the pensioners money, because they lost more in interest than they gained in pension".

The government was also concerned that retirees were subsidising the banks, then Prime Minister Hawke explained in an interview with 7:30's Paul Lyneham.

From 1990, for pensioners' savings greater than $2,000, cash and term deposits were assumed (or deemed) to be returning at least 10 per cent, or the actual rate (or whichever was higher) for the purpose of the income test.

It's worth noting that at the time, the RBA cash rate was about 14 per cent.

Biti says the policy was also implemented to create certainty for retirees.

"Income from assets would swing wildly for people from month to month. Pensioners weren't getting enough certainty for planning. Deeming encouraged people to invest in growth assets. It was a great system and it has been a really effective way to measure income," she says.

Deeming moves in line with the cash rate

Changes to the deeming rate were announced within less than a year of its introduction by then social security minister Graham Richardson. The rate was lowered to 8 per cent in June 1991 following the fall in interest rates. Since 1997, and up until 2016, the low threshold deeming rate has broadly tracked the RBA's cash rate.

For example, in fiscal 2009, the low threshold deeming rate was moved three times to reflect the drastic fall in the RBA cash rate following the 2008 global financial crisis.

Deeming rba cash rate

Data source: Department of Social Services, RBA

Deeming also started to apply to more financial investments like managed investments, loans and debentures, and listed shares and securities in 1996. Today it applies to gold, money in a superannuation fund, certain account-based and lifetime income streams, and insurance bonds (to name a few).

Martin writes that deeming also stopped being a win-win for the government. Today, if a retiree earns more than the deeming rate, "their income is assessed at only the deeming rate".

"If your investment return is higher than the deemed rates, the extra amount doesn't count as your income," Martin writes, citing the department of human services.

Growing disparity between deeming rates and interest rates

In March 2015, then social services minister Scott Morrison announced the government was cutting the maximum deeming rate from 3.5 per cent to 3.25 per cent. The lower deeming rate was also lowered to 1.75 per cent.

Fast-forward 4½ years and the RBA cash rate has dropped five times, from 2.25 per cent to 1.25 per cent in June. The deeming rate has not moved. 

The issue came to a head earlier this month when the RBA cut the cash rate again, lowering it to 1 per cent.

Data from Ratecity.com.au shows major bank 1-year, 3-year and 5-year term deposit rates at June 19 were between 1.80 per cent – 2.05 per cent.

term deposit rates big 4

Data source: Ratecity.com.au

At the major banks, savings account base rates vary between 0.11 per cent and 0.30 per cent. Some of the highest savings account rates outside the major providers go as high as 2.75 per cent (max rate – conditions apply).

National Seniors Australia describes the situation as "inequitable" and "appalling".

"When Treasurer Josh Frydenberg demands that the banks pass on the full interest-rate cut, he should be embarrassed by government’s failure to take the same equitable approach in-house," they said recently.

Labor’s opposition spokesman for families and social services Linda Burney estimates that up to 30 per cent (627,000) of age pensioners who are on part-pensions were adversely affected.

Call for independent body to set deeming rate

As noted above, the Morrison government last week cut the lower threshold deeming rate from 1.75 per cent to 1 per cent for financial investments up to $52,000 (single pensioners) and $86,000 (couples), and the upper deeming rate threshold from 3.25 per cent to 3 per cent for investments over the threshold.

Under the changes, about half a million Australian pensioners will now receive a boost of up to $804 a year – couples receive up to $1,053.

But advocacy groups say this isn't enough.

"What the government is telling pensioners that they are earning 3 per cent on their investments, when most term deposits are not even returning 2 per cent - how is that fair?” said National Seniors Australia chief advocate Ian Henschke.

“Many older retirees, particularly women, rely on bank deposits because they do not have access to the higher returns from superannuation or are uncomfortable with riskier investments like the stock market. They will continue to be punished by higher deeming rates through no fault of their own.”

Henschke is calling on the government to establish an independent body to set the deeming rate of the day.

is an editor for Morningstar.com.au

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