When Reserve Bank governor Philip Lowe pushed down the cash rate to 0.5 per cent on Tuesday, he inadvertently cut the incomes of poorer retirees.
That’s because the rate of return governments “deem” pensioners earn on their assets rose in relation to the interest banks pay on savings accounts, meaning some retirees will receive less pension.
Because of the recent RBA rate cuts, the lowest deeming rate (1 per cent) is now much higher than the interest earned on many savings accounts.
Ian Henschke, chief advocate for National Seniors Australia, said the government must show some leadership and cut the deeming rate to protect poorer retirees from loss of income.
“If they cut the deeming rate, it would be giving money to people who need it and it would go straight into the economy and give people faith that the government was acting in their interests,” he said.
His comments come after Treasurer Josh Frydenberg said in a press conference last week that the government “was having another look at the deeming rate”.
Here’s the deal
Deeming works like this. For single pensioners who have savings of up to $51,799, or couples with up to $86,200, the government assumes (“deems”) interest earned on their accounts comes in at the rate of 1 per cent for the purposes of the age [or other] pension income tests.
On savings above those amounts, the deeming rate is 3 per cent.
So if you earn less than the government assumes on your savings, you receive less pension than you really should.
The loss in pension income is the difference between the deemed rate of return and what the bank actually pays in interest.
The trouble with deeming rates is that, as interest rates fall, more people lose out as the rates on bank deposits fall, too.
The RBA has cut the official cash rate twice since the government, under a lot of pressure, last dropped the lower deeming rate to 1 per cent in July. Now the cash rate is 0.5 per cent, half the deeming rate.
Mr Henschke has called on the government to act.
He wants it to “halve the upper deeming rate to 1.5 per cent and the lower rate to 0.25 per cent, or better still, go back to coupling deeming rates to follow the cash rate”.
The nexus between the cash and deeming rates was broken in 2011 when interest rates went into the free fall that has seen them land at almost nothing.
And the nexus was between the higher rate and the cash rate, not the lower rate that Mr Henschke wants to bring into play now.
As this chart from Canstar shows, interest rates for term deposits and everyday savings accounts have fallen well below the higher deeming rate.
Even the average for regular savings accounts is below the 1 per cent assumed by the government.
So that puts pensioner savers well under water when the current deeming rate is worked against their pension.
For example, “an investment account balance of $200,000, around three-quarters of that is deemed by the government to earn a return of 3 per cent,” Mr Henschke said.
“I challenge anyone who can find a bank willing to pay 3 per cent on a term deposit when the cash rate is now 0.5 per cent,” Mr Henschke said.
“You are more likely to get 1.5 per return on your investment, yet the government deems you are getting 3 per cent.”
The loss looks like this
Let’s put some figures on that.
A person with $200,000 in savings would be assumed by the government to be earning $4500 on the first $150,000 when in reality they would be earning $2250.
For the last $50,000, the government would assume $500 when the truth would be $365.
So all up they would be earning $2615, or $2385 less than the government assumes.
The loss of pension would account for 50 cents in the dollar so they would be worse off by $1192.50 a year, or about $45.85 a fortnight.
“There are one million Australians affected by this because that’s how many people get various pensions,” Mr Henschke said.
“We find that the vast bulk of our members have money in cash, and for over-70s they hold at least 60 per cent of their assets in cash.”