Expert SMSF insights

10 Jul, 2019

How Deeming Rates cut your pension by one-third

Phillip La Greca, SuperConcepts SMSF expert
By Phil La Greca

The recent announcement to lower the official interest rate has put the spotlight on the unchanged Deeming Rate as pensioners face a one-third reduction in their income. 

The Deeming Rates (currently 1.75% and 3.25%) are the notional earning rates the government assumes you should earn on your investments and is used in the calculating a pensioner’s entitlement under the social security Incomes Test.

This amount of deemed income can be higher or lower than the actual income earned on the investments but particularly for older pensioners who are concerned about volatility and capital erosion and invest in conservative products like cash and term deposits the gap has widened significantly. The impact is stark if your investments earn 1% but you are deemed at 3% then the “missing” $2 on every $100 dollars of your investments can reduce you pension entitlement by up to $1 per fortnight.

To replace this without changing your investments will result in the need to expend some of the capital. 

Why doesn't the Deeming Rate mirror official interest rates?

We’ve had 5 interest rate cuts in 5 years since 2015 (with indications of a further cut on the horizon), but the Deeming Rates were last changed in March 2015 by then social security Minister Scott Morrison. When the Deeming Rates were set in 2015 (just after the RBA rate cut in Feb 2015) the official cash rate was 2.25% (cut in May 2015, May 2016, Aug 2016, June 2019 and July 2019) down to 1%.

There are some benefits to the government of the day in not cutting the Deeming Rate because anyone being income tested for pension will be paid a lower pension and cannot compensate for this unless their portfolio is adjusted.

If you’re drawing a retirement wage from social security and superannuation, you’ll be forced to get this shortfall from Capital that is meant to generate your income. As the gap widens between Deeming Rate and official interest rates, the population will find itself either increasingly reliant on fully funded government pension for their living wage; or increasingly reliant on consuming capital with the hope it doesn’t run out while you still need a living wage. 

The wider the gap, the more people on the pension

Herein lies one the problems we face that only a government can solve. If superannuation is designed to get you off the pension, why does a mechanism such as the Deeming Rate act to run your assets out more quickly and put you on the full age pension quicker?

This Deeming Rate gap means it accelerates the “longevity risk” of people outliving their capital as we continue to live longer.

That wasn’t the purpose of the superannuation system when it was conceived in 1985. 

The problem is that the objectives of superannuation weren’t enshrined as a fallback guide for future decisions and instruments such as the Deeming Rate. Superannuation and the Age Pension are the two key pillars of a national Retirement Income Policy and harmonisation and congruence between these two limbs needs to be enshrined.

It is Time to Enshrine our Super

SuperConcepts recently launched our #Time2Enshrine campaign to overcome this very issue raised around the Deeming Rate in wake of the official interest rate dropping. 

We staunchly believe that if Superannuation is defined, and then enshrined, we would avoid such an inherent conflict as we are a seeing when the Deeming Rate and the official interest rate gap widens.

Curiously this only happens when the official interest rate goes down rather than up. In fact, you could suggest the government is adopting the same behaviour they find fault with borrowers when interest rates move. 

We believe the Deeming Rate should be linked to the official Interest Rates to avoid a gap widening that makes pensioners poorer and pushes them to rely on the government sooner by burning their capital. 

Enshrining the objectives of superannuation would see the Deeming Rate naturally linked to the official interest rates because there would be alignment around the requirements of the superannuation system. This alignment around the objectives would surely provide greater certainty and robustness to the system that eases the burden on government of an aging population. 

Superannuation should be more aspirational than just an aged pension replacement. By defining the objectives of super, we would have clarity around how super interacts with the safety net of an aged pension.  

With the objectives of superannuation defined it would require the Deeming Rate considerations to be guided by the objectives and ensuring they are both in alignment for the greater purpose of the system.

Any policy that subsequently affects either superannuation or social security would have to satisfy to the enshrined objectives of super.

The two systems must work together because they have the same purpose for people no longer working. One group receive a tax incentivised income and the other receive direct government funding. 

That is why the government needs to define our superannuation objectives, and enshrine them in legislation to ensure all future decisions are guided by these codified objectives. 

Join the conversation and have your say by sharing and commenting with the hashtag #Time2Enshrine our defined superannuation objectives.  

Phil La Greca is Executive Manager SMSF Technical and Strategic Services at SuperConcepts

 

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