Why bank deeming accounts don't add up

Among the many complexities that have to be negotiated by people understanding their situation for retirement, the concept of ‘deeming’ is high on the list.

Deeming is a process used to simplify the calculation of the amount of income earned by retirees – however, the complexity of rules around deeming might be being exploited by banks offering ‘deeming accounts’.  The reality is that people using these accounts are getting a lower rate of return than they should be.  In fact, if you are using a deeming account, then I think you are almost certainly missing out on investment returns.  Let’s start by looking at what deeming is.

Deeming rules are part of the income test for social security. In this case, I am looking specifically at the case of age-pension recipients.

The deeming rates are used to assess, rather than having to exactly calculate, the income earned from financial investments such as bank accounts, term deposits, managed investments, debentures, shares and investments in precious metals like gold.

Currently, the deeming rates are:

• For a single person, the first $45,400 of financial investments are deemed to earn income of 2.5% a year. Assets over $45,500 are deemed to earn income of 4% a year.
• For a couple, the first $75,600 of financial investments are deemed to earn income of 2.5% a year. Assets over $75,600 are deemed to earn income of 4% a year.

Let’s look at this in practice.  Consider a single person of age-pension age with financial investments (let’s assume a mix of shares and cash in this case) of $100,000.  To work out the ‘deemed income’ we say that the first $45,500 earns 2.5% (a total of $1,137.50), and then the remainder ($54,500) earns 4% (a total of $2,180).  Their deemed income is $3,317.50.

Here is the important point to understanding deeming and deeming accounts.  The $3,317.50 is the value used for the Centrelink income test, regardless of how much income is earned from the investments.  Let’s assume that this person has $50,000 of the money in a term deposit earning 4.5%, generating income of $2,250 a year (for example, ING have a seven-month term deposit advertised offering this interest rate), and $50,000 earning grossed-up (tax-paid) income of 7% a year from bank shares (income of $3,500 a year).  They are earning actual income of $5,570 of income – significantly more than the deemed income of $3,317.50.  For the age-pension income test this is irrelevant.  The figure that is used is $3,317.50, regardless of how much income is earned. 

As an aside, there are unlikely to be any tax considerations.  Because of various tax rules, including the Senior Australian Tax Offset, any person who is receiving some part age-pension is very unlikely to pay tax.

Regardless of how much actual income is earned, the income test is based on the deemed rate of earnings from financial investments.

The Department of Families, Housing, Community Service and Indigenous Affairs (FAHCSIA) provides this summary:

“Deeming assumes that financial investments are earning a certain rate of income, regardless of the amount of income they are actually earning. If income support recipients earn more than these rates, the extra income is not assessed.”

The website emphasises that deeming is not there to limit the income earned, rather it should provide an incentive for people to invest their money to try and receive returns above this amount.  The website adds: “it increases incentives for income support recipients to maximise total income, because returns above the deeming rate are not counted as income.”

Now let’s look at ‘deeming accounts’.

The deeming accounts offered by the ‘big four’ banks are set out below:

These are accounts that exactly duplicate the 2.5% and 4% deeming rates, with some variations in thresholds.

There seems little doubt to me that many of the age-pension recipients that use these accounts do so in the belief that they are limited to earning 2.5% on some of their financial assets, and 4% on the balance.

To be fair, 4% is not a bad rate of return on a cash investment at the moment.  It is possible to earn a little more using term deposits, however 4% is certainly reasonable.  The real loss of income is on the amount invested that is earning 2.5% or less.  In the case of the CBA account, that first $45,400 would be earning a further 1.5% interest if invested at 4% a year in an online account or term deposit – an extra $681 a year or $13.10 a week.  While this does not sound like a huge amount of money, $13 more a week is a good thing, and many people at retirement live under financial pressure.

It should be noted that most deeming accounts are fee-free. If replacing them with another banking arrangement, for example a transaction account and term deposits, make sure that no fees are incurred.  It should not be difficult to do this with some research.

However, the real difference comes when you look at income that might be available if you took money from a deeming account and looked at other income-producing assets.  I looked at a brief example before, being a single person with $100,000 of financial assets.  The deeming rate on this amount is assessed at $3,317.50.  Invested into a term deposit and bank shares, that income return increases to $5,570, or an extra $2,250 a year, or $43 a week.  Potentially, a big difference.

Even using the 4.5% term deposit, sticking with risk-free bank investments, leads to an increase of $1,182.50 a year, or $23 a week.

Conclusion

Deeming rules are part of a retirement landscape that is complex.  The crucial issue to understand is that they are not designed to limit the income you earn from your financial investments. 

Instead, when you come to consider the income you can earn from your financial investments you should ignore deeming rates entirely, and simply concentrate on making good investment decisions to maximise your income. 

Investors with $100,000 in a bank account earning income returns equivalent to the deeming rate could earn an extra $43 a week simply by using a 50/50 mix of bank shares and simple term deposit investments – a nice little retirement bonus!

Scott Francis is a personal finance commentator, and previously worked as an independent financial advisor.