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Ralston on accessing equity in the family home

Dr Deborah Ralston is currently a Professorial Fellow at Monash University and in 2019 she was appointed by Treasurer Josh Frydenberg to the three-member panel for the Retirement Income Review. Exclusively for Firstlinks, she elaborates on the Review's findings on the family home.

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As Bernard Salt’s article in Firstlinks on 'the 2020s baby boom retirement surge' pointed out, Australians retiring today have never been healthier, better educated or longer living. There is an increasing emphasis amongst retirees on quality of life in retirement and maintaining a standard of living commensurate with their pre-retirement lifestyle.

This generation has also had the benefit of rising property values over recent decades, with the consequence that a large proportion of their wealth resides in the family home.

What the Review uncovered about the importance of the family home

This subject was covered in some depth in the recently-released Retirement Income Review (the Review) (All data in this article unless specified otherwise are drawn from this Review).

In examining the three pillars of the Australian retirement system - the age pension, compulsory superannuation and private savings - the Review pointed out that:

The home is the most important component of voluntary savings and is an important factor influencing retirement outcomes and how people feel about retirement. Homeowners have lower housing costs and an asset that can be drawn on in retirement. (p18)

At present, about 80% of retirees are homeowners. This is a high rate of homeownership by international standards that not only benefits individuals but the wider economy. Home ownership lowers age pensioners’ living expenses and means that the system is very cost effective for Australian taxpayers. At 2.4% of GDP, Australia has one of the lowest cost public pensions systems in the OECD.

Patterns of home ownership are changing, however. Housing costs have increased, and people are entering the workforce, marrying, forming households and buying their first home later in life. Between 1981 and 2016 the average age at which people purchased a home increased from 24 to 33, and, as a natural consequence, the average age at which mortgages were paid out increased from 52 to 62 (Review, p122). In 2017-18 around 10% of people entered retirement with a mortgage, a proportion which is increasing each year. Estimates now suggest that may be closer to 20%.

For most Australians, the family home is not only of huge personal and psychological importance, but it is also a major store of wealth. As housing is exempt from the age pension assets test and capital gains tax, for many it is a preferred form of retirement savings. At present, around 15% of age pensioners live in homes valued at more than $1 million, although the vast majority of these are in Sydney or Melbourne where property prices have escalated over recent years.

Many retirees in this situation did not have the opportunity to accumulate much superannuation during their working lives and may be termed ‘asset rich and income poor’.

The family home is a store of wealth which can be used

For median homeowners at retirement, home equity represents around three to four times as much wealth as superannuation (median superannuation balances at retirement are around $200,000, while median home equity of retirees is $750,000). With the family home constituting such a large component of private saving, accessing equity in the family home is an attractive means of increasing retirement income and continuing to age at home.

There are two Government measures to encourage retirees to access the value of their home:

The Pension Loans Scheme (PLS) is effectively a reverse mortgage for age pensioners and self-funded retirees, designed to supplement retirement income up to 1.5 times the maximum age pension per fortnight. There are no regular repayments through the life of the loan, and income from the scheme is not assessable in the age pension means test. It is not possible, however, to borrow a lump sum under PLS.

The impact on capital value of the property is less than you might think. While interest rates are higher for reverse mortgages because there are no regular repayments, the net interest cost after allowing for some increase in property value is quite modest. The RIR gives an example of a retiree who draws $5,000 each year throughout retirement against equity in a home worth $500,000. By the age of 92 the property has an accumulated debt of only around a quarter of its value (Review, p183).

The Downsizer Contribution allows people aged over 65 to enhance retirement incomes by increasing super balances on selling the family home. Provided the home was held for at least 10 years prior to sale, and the $1.6 million transfer balance cap has not been reached, a person can contribute up to $300,000 to superannuation from the proceeds. This could mean a combined $600,000 boost to superannuation balances for a couple.

In the current economic environment, a variety of new forms of private sector home equity access products are attracting more interest from both age pensioners and self-funded retirees. These include reverse mortgages, home reversion or equity release products. Each of these is slightly different, as discussed on ASIC’s Moneysmart website.

Private sector reverse mortgages offer the choice of income stream, line of credit, lump sum, or a combination of these. A lump sum could be used for purposes such as paying out a mortgage at retirement, covering the cost of large expenses such as home renovations, assisting younger members of the family with a home deposit or education expenses, or providing additional resources for in-home or residential aged care.

For an increasing proportion of older Australians with mortgage debt at retirement, refinancing with a specialist reverse mortgage provider is an attractive option. Loan repayments can be drawn against equity in the home instead of being repaid in cash, thereby preserving superannuation balances for retirement income. Importantly, unlike a regular home loan, a reverse mortgage does not require regular repayments and a borrower cannot default for missing payments.

Since 2012, federal reverse mortgage legislation has provided significant consumer protections, limiting loan to value ratios, guaranteeing occupancy, and ensuring people cannot have negative equity in their homes[1]. There are fairly strict limits on what you can borrow against the home, starting at 20% of equity at age 60 and increasing by 1% with each year of age. These measures ensure in all but the most extreme economic scenarios, homeowners can expect to own a majority of their home equity by the time they reach 90 years of age.

Home reversion is a property transaction rather than a loan, where you agree to sell a portion of your property to a provider or investor in return for a lump sum payment. Any future growth in property value is shared, based on the percentages of ownership. The home reversion provider pays a 'discounted' amount for the share of equity, which can be much lower than the current market value. For example, you could sell 50% of the future value your home, but only receive somewhere between 25% and 40% of the value up front, depending on your age.

Home reversion is not subject to the same protections as a reverse mortgage under the National Credit Consumer Protection Acts (NCCP). There may also be limited availability based on location for this product compared to a reverse mortgage.

Not so well known are equity release contracts, where you can sell a portion of your home to one or more investors, in return for a lump sum or a regular income stream. All maintenance, repairs and insurance costs are shared between the owner and the investors. Each five years, an additional small part of equity is used to pay a notional rent to the investor as return on their investment. While the owner retains the title of the property and the right to continue living there, they may also choose to rent the property out and retain all the rental income.

Equity release products do not have a "no negative equity" restriction however, so you need to keep track of your borrowed portion. Geographic restrictions do not apply so equity release can occur anywhere provided property investors can be found. These may be family or friends, self-managed superannuation funds or unrelated parties.

A little known but valuable feature of an equity release product is that they also qualify for the tax-free Downsizer Contribution allowance, allowing retirees to stay in their home but contribute funds from the sale of a portion of their equity into their superannuation accounts.

Each equity access product has different features which may or may not suit an individual retiree’s needs. As the Moneysmart website points out, it is essential to get some independent advice regarding how such a transaction might impact on your age pension entitlements, bequests etc. There is also a fact sheet from Service Australia to assist.

What is the efficient use of retirement savings?

Throughout the Review there are ongoing references to the efficient use of retirement savings. That is, using retirement savings to provide needed funding in the form of both income and capital. This statement has often been misinterpreted to mean that retirees should reach the end of their lives with all retirements savings exhausted, but this is not the case.

It is pointing to the fact that once people reach retirement, they often become very cautious about spending down their retirement savings. Many live frugally in the belief that they should preserve the capital they have saved, only spending returns and dividends, and with a concern that they will ‘run out of money’ before they die. This approach is well motivated in that people feel they are being financially responsible and do not want to be a financial burden on others. But more often than not, this approach means that savings intended for retirement funding, including capital, go unspent and create an unintended bequest for future generations.

As the Review points out, in each decade of retirement we spend less. Concerns of providing for future costs are largely unfounded, as in this country we enjoy a generous system of ‘social transfers in kind’. These are benefits in terms of the health and aged care systems, tax concessions such as SAPTO, social security benefits such as the carer’s pension, and discounted state and local government services such as concessional pricing for public transport, discounted utilities, car registration and council rates. In many ways these transfers represent a fourth pillar of the retirement system and they are not insignificant. Indeed, the Review found that the average value of such benefits is greater than the full age pension for people over 65 (Review, p.134).

The purpose of the government encouraging and supporting retirement saving is to ensure that people can live well in retirement, not save for the next generation. By all means leave a bequest but ensure that this is not at the expense of living well yourself. Drawing equity in the home to ensure you can enjoy your retirement with both adequate housing and funding is another example of using retirement savings well.

Conclusion

For the current generation of retirees, housing represents a significant proportion of wealth. It is likely that an increasing number of retirees will draw on this precious asset to improve standards of living, to pay out a mortgage, or to provide additional resources for those wishing to age at home.

For most people staying in their own home and community is an important priority in later life. The additional income which can be generated from the wealth stored in the family home can ensure a higher standard of living in retirement and is especially important for those who have not had the benefit of higher superannuation contribution levels for much of their working lives.

 

Dr Deborah Ralston is currently a Professorial Fellow at Monash University, where she is a member of the Steering Committee for the Mercer CPA Global Pension Index. She is currently a member of the Reserve Bank of Australia Payments System Board and holds several non-executive director roles. In 2019 Deborah was appointed by the Treasurer Josh Frydenberg to the three-member panel for the Retirement Income Review.

 

[1] Prior to 2012 reverse mortgages were not subject to product specific legislation and were regulated at the state level resulting in highly variable customer experiences and product designs that generated unexpected outcomes for customers and misaligned selling practices.

 

17 Comments
Rob
April 06, 2021

Afraid all of the above ignore the personal and political realities.

I do not trust Canberra to look after me in my dotage and derive great security from owning my own home - where and how I want to live. I will downsize as and when I can no longer cope - my decision and my timing. If I want to save to help my kids and grandkids, I will and no politician will convince me I shouldn't. I seek nothing from Canberra and expect little other than moving goalposts

Yet again Keating nails it - forcing people to "eat their homes" has zip chance of getting up politically

John
April 07, 2021

Hi Rob.
You make the comment, I seek nothing from Canberra, which I am sure is echoed by many others. However, the facts are that the system is greatly skewed by Canberra in favour of home owners. Home owners have their homes value exempt from the Centrelink assets test if they choose or are eligible to claim the age pension and associated benefits. A benefit not available to non homeowners with alternative assets.
Also, retirees with assets in superannuation continue to receive ongoing tax exempt income, as opposed to the working population who continue to pay their fair share of taxes, another generous Canberra benefit.
So, retirees who seek nothing from Canberra are a little bit hypocritical if they do not speak up about the preferential treatment being given them

chris
April 05, 2021

Thanks for the information but where does the figure for "median home equity of retirees is $750,000" come from. sounds like a very capital city centric valuation. i live in a large regional SA city, our house is valued at $370,00 would be $1.5 million in melb or sydney. the majority of retirees i know can only dream of those sort of valuation.

Deborah Ralston
April 05, 2021

Hi Chris, yes I see your point. The ABS measures household wealth on a fairly regular basis, but with around 22 out of 26 million Australians living in capital cities, there will be an upward bias in the value of home equity. The central point here though is that, as the RIR points out, people at retirement will still tend to have more wealth in the home than in super. "Australia’s superannuation system will have matured by the 2040s, when the SG will have been at least 9 per cent for 40 years (the average length of a working life — see 2C. Maintaining standards of living in retirement). Most people entering retirement over the past five years have only had around 20 years of superannuation accumulating at relatively low rates.” P.116

Denton
April 04, 2021

I agree with Dudley. Dr Ralston states: Provided the home was held for at least 10 years prior to sale, and the $1.6 million transfer balance cap has not been reached, a person can contribute up to $300,000 to superannuation from the proceeds.
However, the Australian Taxation Office webpage ‘Downsizing contributions into superannuation’ states: ‘Your downsizer contribution is not a non-concessional contribution and will not count towards your contributions caps. The downsizer contribution can still be made even if you have a total super balance greater than $1.6 million.’
The two statements appear inconsistent. Can a downsizer contribution be made if the super fund balance exceeds $1.6m or not?

Deborah Ralston
April 05, 2021

Apologies Denton and Dudley - my mistake and of course the ATO is correct. The Downsizer Contribution does not count towards the contribution caps.

John
April 06, 2021

Denton,
You are correct, the downsizer contribution does not count towards the Total Super Balance cap, but if you do have more than $1.6M in super (in pension phase) and therefore have reached your Transfer Balance cap, the downsizer contribution will not be able to be rolled to the tax free pension phase. It will remain in accumulation and depending on your personal MTR, maybe paying 15% in accumulation may or may not be tax effective.

Jeff Oughton
April 04, 2021

Congrats for a fact based insightful summary of our retirement income system, but as per the terms of reference there are no systemic policy measures.

80% of elderly Australians own a home and die with 90% of their wealth they had accumulated at the time of retirement or when they ceased earning labour income.

90% of super fund members leave their super funds on retirement.

etc

Elderly Australians under consume and younger Australians are under employed, and then seniors give with a cold hand on death to younger Australians, rather than a warm hand while living.

The quality of life falls well short of potential; Public policy & private market failures involving both providers and elderly Australians deliver these poor outcomes.

Private markets provide very high cost last resort life time loans in excess of 5% pa to only a limited number, and often ill-informed and desperate cash constrained elderly Australians faced with a financial emergency. The government also offers a very simple self funded income annuity, but the PLS is capitalised at an unattractive borrowing cost of 4.5% pa and remains poorly advertised and distributed by Services Australia.

The wellbeing of many elderly Australians is lacking due either their inability, irrational behaviours or poor incentives to make well-informed choices during the last 25 years of life. Private providers manufacture highly complex products and sell with their interests in mind. Politicians seem captured by vested interests, lack public policy advice and the foresight to fix the private market failures.

Both young and old Australians expectantly await government solutions to the inefficient over-saving by the majority of elderly Australians living in their homes.

davidy
April 02, 2021

Simple - all of the above are too complicated for most people to understand or trust hence they stay in their homes and do nothing.

Stewart
April 04, 2021

Brain surgery, car engines and technology is too complicated for many people which is why you engage a professional. If you don’t like the option that enable you to access equity and stay out then do nothing and pay whatever that price is, or sell up buy something cheaper and pocket the difference. Horses for courses. No one option suits everyone, and of course there are no free lunches, there is a cost just as there is for everything. Questions are good but personal opinions/prejudices are worthless. Thanks for the clear explanation of the trends and the basic differences in the ER options available.

Jeff Oughton
April 05, 2021

Here's simple
1. reduce the PLS borrowing cost and make the rate attractive/fair....
the govt borrows at 0.25% for variable rates and 2.5% for 20 years add operating costs of 1% equals a public policy rate of 1.25% for variable and 3.5% for 20 years...AOFM manage the funding .....
2.. rebrand and promote the PLS
home pension.....promote/advertise the benefits ...1.5 X boost to the aged pension, tax free ......COVID saw tele health/medicare switched on ... start tele financial advice on this simple income annuity supported by data base, advisers etc already available at Services Australia
3. ..introduce flexible lifetime loans into the govt scheme...a bit less simple e.g. a line of credit secured against their home that releases capital/private savings ...sends the borrower a lump sum to their govt linked bank account...this requires the govt to make a small investment into the systems at Services Australia
4. etc
5. etc

Ryan
April 01, 2021

The capital cost for assisted aged care, depending on location, is in the vicinity of $400k plus ongoing fees of $400 per week per person. Proposals being put forward to encourage, or in some cases require, retirees to access the equity in their house will reduce the ability of retirees to fund the cost of aged care in later life, requiring the government to fund more aged care places, increasing the impost on government budgets.

Rick
April 01, 2021

I admit I'm not sure how the Pensions Loan Scheme works but if the example pensioner gets $5,000 a year on a home worth $500,000 and 25 years later the debt is 25% of the value of the house at that stage, something doesn't add up. I bought a house for $820,000 twenty five years ago, and it is now worth five times that. So if I opted for the scheme 25 years ago and die today, does that mean the outstanding debt is well over $1m and I would have received about $200,000? If so, that's a pretty lousy deal. The scheme sounds ok until you read that the model assumes house prices grow at the same rate as wages. How likely does that sound?
Also, if I had made a downsizer contribution with what I was given, and adult children inherit my super they will pay 15% tax on the balance. If they inherit a $4m principal residence, they get it tax free if they sell it within two years of my death.

Ross
April 01, 2021

The the Equity release product like the reverse mortgage products do allow a no negative equity clause. Therefore a retiree can remain living in their home after all their equity is exhausted. That is incorrectly stated in the article.

Mick
March 31, 2021

This article doesn't mention the Pension Loans Scheme's exorbitant interest rate of 4.50% pa, which is compounded.

The full amount of the loan plus interest owed at the time of the death of the person will be recovered from the person’s estate. So if the retiree's surviving children live in the house, they risk getting the boot.

No wonder retirees avoid the PLS.

Dudley.
March 31, 2021

Retirement Income Review did not consider the post-retirement, pre-mortem phase - the dying phase.

Initial capital cost of dying phase care is about one house per person. On-going cost is, not coincidentally, the full Age Pension payment per fortnight.

Exhaust financial capital by post-retirement if you dare and can time that so finely. But take care not to spend the home equity entrée to decent assisted dying phase accommodation.

Dudley.
March 31, 2021

"Downsizer Contribution ... over 65 ... Provided ... the $1.6 million transfer balance cap has not been reached":

'From 1 July 2018, if you are 65 years old or older'

'Your downsizer contribution is not a non-concessional contribution and will not count towards your contributions caps. The downsizer contribution can still be made even if you have a total super balance greater than $1.6 million.'

'The downsizer contribution will count towards your transfer balance cap, currently set at $1.6 million. This cap applies when you move your super savings into retirement phase.'

https://www.ato.gov.au/Individuals/Super/Growing-your-super/Adding-to-your-super/Downsizing-contributions-into-superannuation/

 

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