What low interest rates may mean to you
By Colin Lewis, June 2019
With the Reserve Bank recently cutting the official cash rate to a historic low of 1.25 percent and the likelihood of further cuts to come, investors are seeing their returns eroded.
For retirees with investable assets sitting in cash, term deposits and fixed interest securities, lower returns mean less income to fund their retirement lifestyle.
Hardest hit are self-funded retirees. Without the safety net of the indexed Age Pension, they are reliant solely on their own resources to generate the income they need to live on.
For self-funded retirees with surplus income, lower interest rates may not impact their lifestyle and no adjustment to their current arrangements may be necessary.
However, for people invested in cash and term deposits whose income matches their expenditure, lower rates will bite. It may ultimately mean eating into capital to sustain their lifestyle – the last thing investors want to do.
For many retirees, the question is: Do you wish to maintain your lifestyle or are you prepared to accept something less? The former may require taking some action whereas the latter means doing nothing.
So, it comes down to making your money work harder for you or changing your lifestyle by either returning to the workforce – if that’s even possible – or revising your retirement goals. Or it could be a combination of the two depending on how far interest rates fall.
From 1 July 2019, changes to the Work Bonus mean that Age Pensioners can earn up to $300 a fortnight without impacting their pension. Provided you stay below the annual maximum of $7,800 a year, you can earn more than $300 in a fortnight and your pension will not be affected. Together with the income test free area of $172, you can earn $472 a fortnight before your pension is affected – giving you more money to live on.
Generally, investing for a better return will mean taking on additional risk as you’ll be investing in riskier and more volatile asset classes to get that return, e.g. Australian and international shares, and property.
Recently, shares have gone up as the valuation of dividend income streams has risen as rates fall. But with interest rates falling, is now the time to jump into shares when there’s much talk about the share market being overpriced and the strength of the Australian economy is in question?
If you are attracted by high returns in this low interest rate environment, be very mindful of what you’re getting into. The adage, “if something seems too good to be true, it probably is” comes to mind. Over the years, there’s been a string of corporate collapses where investors have been enticed into them with the promise of high returns. Classic cases include Basis Capital, Australian Capital Reserve, Westpoint, and further back Estate Mortgage and ASL.
Always invest with your eyes wide open
Revising your lifestyle goals could mean holidaying in Australia rather than overseas or travelling overseas less frequently. It may mean updating your car say every seven years as opposed to five; drinking a $10 bottle of wine rather $15 to $20 bottle; buying cheaper cuts of meat at the butchers or supermarket.
It all depends on your situation and it’s all about trade-offs
If you’re approaching retirement, rate cuts could lead to delaying your retirement to work a little longer to bolster your retirement savings – as was the case for many people during the GFC.
This way you start retirement with a larger nest egg to compensate for the lower returns that will be generated from it to maintain the income level you planned to have for the lifestyle you wish to lead.
However, should you choose to stick with your retirement date then it may mean either changing your retirement plan – revising your lifestyle goals – or investing for a better return to fulfill that plan.
Again, it’s about trade-offs
Saving smarter is important and using the superannuation system is one way of doing this. Upcoming changes to super may help you save in this concessionally taxed environment longer.
These changes include the new work test exemption from 1 July 2019 and the proposal announced in the April Budget to give people aged 65 and 66 from 1 July 2020 the ability to make contributions without meeting the work test.
Senior Australians are means tested to determine their entitlement to the Age Pension. Under the income test, financial assets are ‘deemed’ to earn a specified return. The deeming rules incentivise investors to earn more from their savings. If pensioners invest and get higher returns, their total income will increase.
Currently, the higher and lower deeming rates are 3.25 and 1.75 percent respectively – certainly out of kilter with the official cash rate.
Deeming rates are monitored on an ongoing basis and are generally changed to coincide with the indexation of pensions – less disruption to pensioners by minimising changes to their payments. However, changes can be made at any time if there are significant movements in returns.
Consequently, when interest rates are falling there will be a time lag before the deeming rates change which may result in pensioners impacted by the income test receiving less from their investments without a corresponding increase in their pension.
If you or your partner are Age Pension age or older, own real estate in Australia and need more income to maintain your standard of living then you could consider the government’s Pension Loan Scheme (PLS) – effectively a reverse mortgage.
From 1 July 2019, all Age Pensioners and certain self-funded retirees can leverage the equity in their property under the PLS by borrowing up to 150 percent of the maximum fortnightly pension rate of $907.60 at a current interest rate of 5.25 percent per annum.
Whilst the loan can be repaid any time, normally it will be recovered when the property (usually your home) is sold from your estate.
If you’re contemplating such a loan, you need to carefully consider the downside. It will reduce the value of your property when it’s sold.