Drawdowns and deeming - now they must be fixed

The $1.6 million super cap will not help already challenging deeming and minimum withdrawal rules.

Summary: The proposed $1.6 million limit on tax-free superannuation accounts in pension mode should make the government think about modifying minimum withdrawals from super accounts, as the limit will already create a disincentive to use super as a wealth accumulation vehicle. Deeming rates should also be reviewed in the current low interest environment, as the income that is ‘deemed’ to be generated from many cash investments might be higher than the reality.

Key take out: In this environment of low share market returns and a low cash rate, reviewing the deeming rules and minimum withdrawal requirements would be more fair to superannuation accountholders.

Key beneficiaries: General investors.  Category: Superannuation.

The $1.6 million proposed limit

Those people planning for retirement, and indeed those already in retirement, face a change to the superannuation landscape with the proposed limit of $1.6 million in a person’s superannuation fund being able to be transferred to a pension. 

The benefit of having assets in a superannuation pension fund is that the fund is no longer taxed at the 15 per cent superannuation tax rate; it is taxed at a zero per cent tax rate.  Placing a limit of $1.6m on the amount of superannuation a person can have in a pension account puts a significant limit on the way superannuation assets can accumulate. This $1.6m proposed limit is also planned as a retrospective step – meaning that all people with superannuation, retired or heading to retired, will be impacted.

Minimum pension fund withdrawals

Given this key proposed limit on superannuation accumulations being transferred into a superannuation pension fund, it is a reasonable time to consider another current limit on superannuation – the compulsory minimum withdrawal rates from a superannuation pension fund. These minimum withdrawal amounts, set out in the following table, dictate how much must be taken from a superannuation pension fund each year based on the age of a person – with the minimum withdrawal increasing as a person ages.

Age of pension account-holder

Percentage factors

Under 65

4%

65 to 74

5%

75 to 79

6%

80 to 84

7%

85 to 89

9%

90 to 94

11%

Aged 95 or older

14%

The effect of these minimum pension withdrawal rates is to limit the ability of a person to simply use their superannuation pension fund as a vehicle to accumulate wealth that gets passed onto future generations.  Given the $1.6m limit on transfers into a superannuation pension fund, it is reasonable to reconsider the need for these minimum withdrawals, as the $1.6m limit will do this.

For a person in retirement – self funded or contributing to their own retirement through the use of their pension assets – being forced to take a minimum pension withdrawal amount can be problematic.  This is especially true in a time when the RBA cash rate is 1.75 per cent – a superannuation pension fund might be earning two per cent on the cash in their fund, but is forced to withdraw at twice this rate to meet the minimum pension requirement – effectively people are forced to withdraw some of their capital from their superannuation pension fund. This is not a pleasant task, especially given that each year inflation is also reducing the capital value of their pension fund. Sure, it is likely that superannuation investments in listed property trusts and Australian shares will be earning income at a higher rate that a 2 per cent cash investment, however forcing retirees to withdraw from their superannuation pension fund at an ever increasing rate above the rate of income earned make retirement planning harder than it needs to be. This is especially true if there is also a limit of $1.6m of superannuation assets that can be transferred into the pension phase.

It is not as though there is not a precedent for changing minimum withdrawal rates from a pension fund – during the Global Financial Requirements minimum withdrawal rates were halved to help retirees cope. It is not unreasonable to suggest a historically low cash rate means retirees deserve consideration as to how they are coping with this situation.

Surely if the $1.6m limit on superannuation pension accounts comes into play, limiting people’s access to the zero per cent taxed pension environment, it is time to allow them more freedom to manage the rate at which they withdraw from their pension fund, rather than mandating minimum pension withdrawal rates that force them to withdraw their capital.

Deeming rules

Another key retirement setting that is in need of review is that of deeming rates. Deeming rates are the rates that are used to calculate the rate on income earned on financial investments for Centrelink purposes, including in the case of age pension eligibility. For a couple, the first $80,600 of financial assets are “deemed” to earn 1.75 per cent, with any amount over that deemed to earn 3.25 per cent. For a single person the rates are the same, with the first $48,600 being deemed to earn the lower rate of 1.75 per cent.

In an environment where a cash investment might be earning somewhere around 2 per cent, having income from a cash investment “deemed” to earn 3.25 per cent seems unfair on those people who are impacted by the deeming rules.  Effectively they will be receiving significantly less in income than they are deemed to have earned.  For most of the time that I have been working with deeming rates, they have generally been fairly generous – usually underestimating the amount of income that would be earned from a cash investment.

For example, in March 2008 the RBA cash rate was 7 per cent. My memory is of some term deposits around this time offering returns of between 7 and 8 per cent. The top deeming rate was 6 per cent.  It was very likely that you could earn more in a cash investment that your “deemed” income.  Fast forward to today – and the deeming rates are higher than the likely cash return. This does not seem fair.

A challenging environment

When we talk about an environment how deeming rates and minimum pension withdrawals are making it difficult for investors, we are talking about an environment where share market values are still significantly below 2007 levels, cash rates are at historical lows with an RBA rate of 1.75 per cent and we are six months away from more restricted access to the age pension. 

Governments could help make this environment less challenging by linking deeming rates to the actual cash rates of return that are available and, particularly if the $1.6m superannuation pension fund limit is introduced, relax the minimum pension withdrawals so that retirees are not being forced into withdrawing their capital from their superannuation funds.

These two modest changes would help retirees navigate a challenging environment.