You may have recently heard a fair amount of talk about deeming rates lately. Find out what they are and why they’re a hot topic right now.
- Why are deeming rates in the news?
- What is ‘deeming’?
- Who does ‘deeming’ apply to?
- What are financial assets?
- What are deeming rates?
More than one in seven Australians are aged 65 years and over, according to the latest population data, with the majority of those receiving at least a partial age pension.
This leaves the finances of many older Australians at the mercy of government-set deeming rates, which influence how much pension someone is eligible to receive.
Looking for a good term deposit? The table below displays some of the highest term deposit interest rates available for a 6-month term.
Why are deeming rates in the news?
Deeming rates have been a hot topic over the last 18 months, off the back of the Reserve Bank (RBA) making six cuts to Australia's cash rate. The Federal Government has cut the deeming rates three times since July 2019 in response to these cuts.
After two RBA cash rate cuts in March of last year, Prime Minister Scott Morrison cut the rates twice, in an effort to cushion the fallout from COVID-19. That change was forecast to benefit around 900,000 income support recipients, costing the government almost $900 million.
At the time, head of consumer group National Seniors Australia, Ian Henschke, commended the government for taking action and coming to the aid of older Australians.
“The cut to deeming rates and drawdowns were necessary to assist older Australians whether they invested cash in a bank or in the share market which has lost a third of its value since this crisis began,” Mr Henschke said.
“Even before this crisis began, older Australians have been doing it tough with vast numbers unable to get work and they have had to eat into their savings and super as they headed to the pension age."
The 2019 decision to cut deeming rates was made amid increased pressure from retiree groups and age pensioners, who said retirees on the age pension were being unfairly punished by the Reserve Bank’s June and July cash rate cuts, which in turn reduced the interest rates on most term deposits and savings accounts. Many retirees rely on the interest from these products as their income, so to them, a cash rate cut is essentially a pay cut.
But between May 2015 and July 2019, the rate of income (e.g interest and dividends) that Australian pensioners were “deemed” by the government to earn on their wealth remained the same, despite there being four cash rate cuts over the period. This meant that for many pensioners, the government was assuming they were earning a lot more interest than they actually were, which affected how much pension they qualified for.
Amid the inaction on deeming rates, the government was accused by Labor and other industry bodies of using pensioners to prop up the economy.
"The Coalition's track record has been to reduce those deeming rates, consistent with the interests of senior Australians and other savers across the community," Mr Frydenberg said.
Shortly after the November rate cut, RBA Governor Phillip Lowe said savers and those relying on interest income, like pensioners, would be most hurt by the low interest environment.
"The harsh and unfortunate reality here is that you’re going to get a low return on your savings," Dr Lowe said.
“So the solution here is to get businesses to invest and to have other individuals want to use their income to spend rather than to save.
What is ‘deeming’?
Deeming is a set of rules that government groups will use to estimate your income from your financial assets.
It assumes these assets earn money, regardless of whether they actually do or not.
Who does deeming apply to?
Deeming applies to anyone receiving government payments and benefits, such as the:
- Service pension: Granted to veterans on the grounds of age or invalidity, their eligible partners, and widows and widowers.
- Veteran payment: Interim financial support to veterans who have lodged a claim for a mental health condition and are incapable of working more than eight hours per week.
- Income support supplement: A regular income for war widow(er)’s with limited means or a wholly dependent partner.
- Age pension: Income support for Australians 66 years and older.
- Commonwealth Seniors Health Card (CSHC): For those not receiving any of the above, and are either a veteran, widow(er), or above 60 years of age, the CSHC card entitles the holder to concessions in the health sector.
What are financial assets?
Under deeming, the main financial assets that are assessed include:
- bank accounts and term deposits
- managed investments, loans and debentures
- listed shares and securities
- new account-based income streams (such as a pension)
- money in a super fund that is in the accumulation stage and not paying you a pension
That’s not a complete list by the way – we’ve kept it short in an attempt to stop you from falling asleep or moving on to more exciting financial topics like collateralised mortgage obligations. But keep in mind that things like vehicles, real estate investments and antiques aren’t counted as financial assets.
So what are deeming rates?
Essentially, deeming is a system used by the government to assess how much money you’re entitled to for your pension. It’s a tool that’s supposed to account for the entire scope of your wealth and potential income, rather than just how much money you have in savings. For example, if you had money in shares, term deposits and your savings, deeming makes a broad assumption of what that financial portfolio generates in income (dividends, franking credits, interest etc.).
Now let’s introduce the actual deeming rates themselves. There are not one, but two deeming rates: the higher deeming rate and the lower deeming rate. There are also different rules for singles and couples, so as not to discriminate against you silver-haired bachelors and bachelorettes.
The lower deeming rate applies on the portion of the portfolio up to the government-specified deeming threshold, while every amount above this threshold is deemed to earn the higher deeming rate. According to the government, the purpose of this is to provide an incentive for pensioners to invest and earn more of a return than the deeming rates will provide.
From 1 May 2020, the thresholds are:
- For singles: $53,000
- For couples: $88,000 (combined)
From 1 May 2020, assets up to these amounts are deemed to earn the lower deeming rate of 0.25% p.a., while amounts above are deemed to earn the higher deeming rate of 2.25% p.a.
To get the full pension, a single pensioner can have an “income” of up to $4,524 per year, or $178 per fortnight before their pension starts to be reduced. For every fortnightly dollar of income over $178, the pension will be reduced by 50 cents per fortnight. If a single pensioner is deemed to earn $53,732 or more per year ($2,066.60 or more per fortnight), they are ineligible for any pension.
Case Study: Doris
Let’s use Doris as an example to break things down further. She’s a single 74-year-old who loves a Cab Sav and Hugh Jackman.
Doris’s total financial assets come to $75,000
- The first step is to calculate her deemed income up to the deeming threshold of $53,000, using the lower deeming rate (0.25%): $53,000 x 0.0025 =$132.50
- The second step is finding out how much money Doris has over the threshold, by subtracting the deeming threshold from her total financial assets: $75,000 – $53,000 = $22,000
- The third step is calculating her deemed income on this amount over the threshold, using the higher deeming rate (2.25%): $22,000 x 0.025 = $550
- The fourth step is adding both the deemed incomes, which will give us Doris’ annual deemed income: $132.50 + $550 = $682.50
Doris’s annual deemed income is $682.50, which is well below the full pension annual income threshold of $4,524 and would allow her to collect the full pension amount without reduction.
Case study: Boris
Now let’s look at an example of someone called Boris whose pension may be reduced by having a deemed income above the full pension threshold. Boris is a single 69-year-old who loves blue cheese and Barbra Streisand.
Boris’s total financial assets come to $500,000
- Like Doris, Boris’s deemed income on the first $53,000 of his wealth is $132.50
- His wealth above this threshold is $500,000 – $53,000 = $447,000
- His deemed income on this amount is $448,000 x 0.0225 = $10,080
- His total annual deemed income is $132.50 + $10,080 = $10,212.50. This is $392.79 per fortnight.
- His fortnightly income is $214.79 above the full pension threshold ($178). Single pensioners see their pension reduced by 50 cents for every fortnightly dollar above the threshold, so his pension will be reduced by $352.50 x 0.50 = $107.40 per fortnight
Boris’s deemed income is $10,212.50 per year, or $392.79 per fortnight. He will earn a part pension which is $107.40 per fortnight less than the full pension.
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Deeming rates were devised as a way to incentivise pensioners to seek bigger returns for their wealth because some were trying to maximise their pension by minimising their actual income. By earning a higher rate of income than the maximum deeming rate, you can essentially earn bonus income that isn’t assessed in the income test for the age pension.
The trouble is, in a record-low interest rate environment like today’s, it can be hard to find a bank that offers senior savings accounts or term deposits that pay more than 2.00% p.a. in interest. But if you’re willing to take on a higher degree of risk, you may be able to earn a higher income yield by investing in other asset classes, such as shares, bonds or property. Investment funds such as ETFs (exchange-traded funds) can be an easy and low-cost way of gaining exposure to a diversified portfolio of such assets.
Investing can generate an annual dividend at a rate that is significantly higher than what could be earned in a savings account or term deposit, not to mention the potential for high long-term capital gains. Consider consulting a qualified financial adviser to discuss your options.
Photo by Raj Eiamworakul on Unsplash