CPD: The role of the Centrelink PLS in addressing Australia’s retirement funding challenge

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Home equity can play an important role in retirement funding.

Australia’s retirement income policy has been traditionally framed as having three pillars: superannuation, non-superannuation savings and the Age Pension. However, for many Australian baby boomers these three pillars provide inadequate resources to fund 25+ years of retirement. Will the government’s revamp of its Centrelink Pension Loans Scheme (PLS) fill the void? Household Capital discusses the important role home equity can play in retirement funding; it examines where the traditional bank reverse mortgages fell short and the role the Centrelink PLS and other strategies can play within a broader long term retirement plan.

Australians are living longer; since the introduction of compulsory super, Australian retirees have gained an extra decade of longevity. This extra time in retirement should be celebrated, but for many there’s a major downside – a longer lifetime to fund.

Superannuation assets totalled $2.8 trillion at the end of the March 2019 quarter; despite this growth, for many people approaching retirement – or already retired – super came in partway through their working lives. With 3% contributions halfway through a working career, more than half of Australians retiring now have less than $200,000 in super – and that typically has to last more than 25 years.

It’s difficult to plan retirement down to exact specifics. No one knows exactly how long they’ll live, what their medical needs may be, whether they’ll be able to stay in their own home and what renovations or modifications it might need for them to live well at home. Alternatively, who knows when – or if – they will need to fund an aged care place? These unknowns make it difficult to plan exactly how much money is needed to fund retirement.

Retirees tend to fall into one of two camps:

  1. they spend too much, too soon and the back end of their retirement suffers, or
  2. they underfund their retirement, take only the minimum drawdown and save everything for the end; along the way, their wellbeing suffers.

Either way, the long term plan fails to meet retirees’ ongoing needs; getting the long term plan right is the only way to be confident of a positive retirement lifestyle.

A comfortable retirement

Retirees have different dreams and aspirations for retirement. It might be spending more time on favourite pastimes or creating memories with friends and family. For many, being able to enjoy a comfortable lifestyle in their family home is central to their plans and important for their wellbeing.

As people age, their spending requirements change, and they often require a higher level of care and support, whether in the home or an aged care facility. This has an impact on their expenses and retirement savings.

Each quarter, the Association of Superannuation Funds of Australia (ASFA) publishes its Retirement Standard, which benchmarks the annual budget needed by retired Australians to fund either a comfortable or modest standard of living in their post-work years. It is updated quarterly to reflect inflation and provides detailed budgets of what singles and couples would need to spend to support their chosen lifestyle.

A modest retirement lifestyle is considered better than the Age Pension, but able to afford just basic activities. A comfortable retirement lifestyle enables an older, healthy retiree to be involved in a broad range of leisure and recreational activities and to have a good standard of living.

Both budgets assume that the retirees own their own home outright and are relatively healthy.

 

 

It’s a reasonable assumption that most retirees would aspire for a comfortable retirement, one which includes more of life’s small luxuries and which is more likely to meet the expectations people had for retirement. As illustrated in figure two, a comfortable retirement allows for the purchase of things such as household goods, private health insurance, a reasonable car, good clothes, a range of electronic equipment and holidays. For those living a modest retirement or reliant on the Age Pension, there are few luxuries and they are less likely to have access to contingency funding for the unexpected.

Unfortunately, for some older Australians, retirement is more nightmare than dream, particularly if they’re relying solely on the Age Pension, which isn’t enough for most. With an inflation rate higher than the interest rate on most term deposits, and limited bank credit available, retirees are feeling the squeeze. This will impact their standard of living and ultimately impact the broader economy.

 

 

According to data from The Household, Income and Labour Dynamics in Australia (HILDA) Survey – Wave 15, today’s retirees spend more than previous cohorts[1]. Figure three compares the average 2006 total household expenditure against expenditure in 2014 by age group. In each age group, retirees spent more in 2014 than 2006.

Younger retirees spent, on average, 16 percent more in 2014. The difference is greater among older retirees, with households aged 85 in 2014 spending 36 percent more than comparable households in 2006.

 

 

The fourth pillar of retirement funding – home equity

Australian retirees have to draw on their lifetime savings to fully fund their retirement and to enjoy 25 years of the good life. Most Australian retirees have 3-4 times the amount of savings in their home relative to their superannuation.

However, many Australians hold the perception that super is the only retirement nestegg they have. Australia’s retirement income policy has been traditionally framed as having three pillars: compulsory superannuation, voluntary superannuation contributions and the Age Pension.

However, for many Australian baby boomers these three pillars provide inadequate resources to fund 25 plus years of retirement. As described in a previous article, it’s now time to include the fourth, and largest, pillar of retirement funding – home equity.

The Australian home equity access market

Home loan line of credit or offset facilities

Some working Australians nearing retirement establish or preserve a line of credit or offset facility against their home mortgage. Several problems arise in the current use of lines of credit to fund long-term retirement.

For most retirees, new mortgages with significant offset facilities are hard to establish at or near the point of retirement. Standard bank terms mean that retirement or other loss of income may be grounds for default, repossession and eviction, undermining the security of tenancy sought by the retiree.

While an offset provides some form of contingency funding, the moment it is drawn down for regular income or an unexpected expense, interest payments on the loan start again. Rather than increase available retirement income, the interest expense of regular or “forward” mortgages depletes available income during retirement.

In these ways a line of credit or offset approach to accessing home equity can put at risk both key retirement objectives of secure housing and reliable income.

Home reversion schemes

In a home reversion scheme, the retiree sells a proportion of the equity in their home while still living there. In contrast, a reverse mortgage is a loan.

It can be difficult to work out how much a home reversion scheme will cost because the scheme reduces or ‘discounts’ the money received upfront. Consider the following example from ASIC’s MoneySmart:

A home is valued at $200,000 and the client sells 50% of the future value of their home. Because of the discount value, the client may receive $35,000-$65,000, depending on their age. The amount of this discount depends on many factors, including age and life expectancy.

There are several potential problems with this approach. Pricing the property in an off-market transaction may not be transparent and may work to reduce the value of the home realised by the retiree. While vendors claim a “no debt” approach, a time-value of money is still applied.

Calculation of the “rental” and adjustments for unusual longevity events makes it difficult to apportion risk between parties and to communicate those costs and risks to the vendor. Finally, home reversion schemes have, to date, applied a significantly higher cost of capital to access home equity.

Traditional bank reverse mortgages

In Australia, reverse mortgages were provided by CBA (and BankWest), Westpac (under the St George and Bank of Melbourne brands), and Macquarie Bank. Heartland (NZ) (formerly Seniors Finance Australia) currently provides reverse mortgages in Australia.

This market comprised standard lump sum reverse mortgages, often provided for short term consumption. As a result, this funding solution was not always aligned with the long-term housing, income and ageing needs of Australian retirees and did not provide genuine retirement funding adequacy and certainty. As well as failing to meet the widespread needs of Australian retirees, the banks then withdrew from the Australian reverse mortgage market; in the past 12 months, CBA, Westpac and Macquarie have all exited.

ASIC’s 2018 Review of Reverse Mortgages found significant shortcomings with traditional reverse mortgage products. ASIC found that the short-term focus resulted in borrowers facing the risk of being left with insufficient equity in their homes to pay for future financial needs.

New entrants to the reverse mortgage market

New entrants with an innovative approach to long term retirement funding are reinvigorating the reverse mortgage market. Responsible retirement funding needs which may be met with access to home equity, include:

  • super top up
  • home improvements for aged living
  • in-home care
  • intergenerational giving for a first home deposit or education fees
  • transition to aged care

For this approach to work, long-term retirement funding needs are largely met by the transfer of home equity to appreciating assets which can flexibly meet those funding needs over time. On the other hand, credit is constrained for short-term consumption of home equity or deployment to depreciating assets.

ASIC’s conclusions from its 2018 review are a resounding endorsement of the need to consider long-term retirement needs in accessing home equity.

“Older Australians should have fair and equitable access to equity release options such as reverse mortgages” – Source: ASIC 2018

New products are subject to the same regulatory environment as previously; ASIC’s 2018 review of the sector concluded that the 2012 consumer protections were functioning and did not need major reform.

Government schemes

Despite the failure of the banks to meet retirement needs, the federal government has acknowledged the important role that savings built up in the family home can play in funding retirement. It has done this through its Downsizer Measure (which supports downsizing) and the upgrade of the Centrelink PLS.

Downsizing

Selling the family home, moving to a lower-priced property and using the differential to fund retirement is often suggested as a major opportunity to improve access to home equity.

On 1 July 2018, the federal government introduced its Downsizer Measure to incentivise retirees to downsize to release some of the equity built up in their family home. Using the government’s Downsizer Measure, retirees can sell their principal residence, which must have been owned for at least 10 years, and make a non-concessional super contribution up to $300,000 ($300,000 each for couples) from the proceeds.

According to an announcement from Michael Sukkar, Minister for Housing and Assistant Treasurer, older Australians downsizing from their family homes have contributed $1 billion to their superannuation funds since 1 July 2018.

This billion dollars came from 4,246 retirees using the Downsizer Measure; while it may seem a large number, it is not statistically significant. In fact, it is is less than one percent of the approximately five million over 65s residing in Australia.

The wellbeing that flows from remaining in the family home and community is an important consideration for retirees. Downsizing often results in disruption and dislocation and doesn’t always deliver financial advantage. It has a number of limitations, including:

  • Australian retirees are reluctant to downsize, identifying their current home as optimal for ageing in place
  • People have emotional ties to their homes and belongings; not only does downsizing take them away from their family home, they often have to minimise the contents that move with them
  • In many areas, there is limited available stock of lower-priced accommodation, meaning that retirees would need to leave their community and social support structures to capture meaningful proceeds from downsizing
  • In many cases, legal and transaction costs, stamp duty and moving expenses erode the realised value of downsizing
  • Tax and transfer systems may result in assets released from home equity downsizing having a potentially adverse impact on assets and income tests for access to the Age Pension
  • Downsizing is highly complex and disruptive.

The Pension Loans Scheme

Although not new, the Centrelink PLS – a government administered reverse mortgage – offers support for eligible seniors in the form of an Australian Government loan, for a short time or for an indefinite period.

From 1 July 2019, the Centrelink PLS was expanded to provide broader access for retirees. All Australians of Age Pension age currently receiving an eligible pension are now able to access the PLS.

Through this scheme, the government draws on the recipient’s home equity to provide a regular income stream alongside the pension. Centrelink PLS loans are offered at a fixed interest rate set by the Minister, currently 5.25 percent and require homes to be valued annually. Payments cease if the loan amount exceeds the applicable LVR.

The PLS commenced in 1985 and expanded to a new scheme in 1996. The original Centrelink PLS was introduced to assist ‘assets tested’ age pensioners, in particular farmers, who were ‘assets rich, income poor’ and featured a simple interest rate.

In 1997, the Centrelink PLS was expanded to include income tested age pensioners and the interest rate formula was changed to compound interest. In its previous form, take up was slow – it remains to be seen whether the changes that came in on 1 July 2019 make it more attractive to pensioners.

Key changes and features from 1 July 2019

The PLS will continue to be administered by Centrelink and paid with relevant pension. The first step in the application process is to meet with a Centrelink Financial Information Services Officer.

Changes

  • Eligibility will now extend to all Australians of Age Pension age, including those currently receiving the maximum rate Age Pension
  • The amount a retiree can receive per fortnight will increase from 100% to 150% of the maximum fortnightly pension rate
  • To qualify, the retiree must receive an eligible pension:
    • Age Pension
    • Bereavement Allowance
    • Carer Payment
    • Disability Support Pension
    • Widow B Pension
    • Wife Pension
  • To qualify, retirees must also:
    • own real estate in Australia with enough equity to secure the loan
    • be of Age Pension age or older, or have partner of this age – this might be older than 65 (i.e. eligibility for Age Pension now commences between age 65.5 and 67)
    • have adequate insurance to cover the secured real estate (these are new requirements)
    • not be bankrupt or subject to a personal insolvency agreement (these are new requirements)
  • Existing recipients can apply to increase their payments, subject to the new qualification criteria outlined above.
  • The maximum income available of a combined Age Pension and Centrelink PLS income stream is 150% of the Age Pension rate per annum.

Individual amounts dependent on whether applicants receive a full or part pension. Figure four compares how a person receiving the maximum Age Pension plus PLS fares when compared to ASFA’s retirement standards. While the PLS can enhance retirement living standards, for a retiree solely reliant on the Age Pension, it is unable to provide for a ‘comfortable’ standard of living.

 

 

Any Centrelink PLS loan amounts received are not taxable and do not count in terms of the Age Pension income test. While the Age Component Amount (which acts the same way as a loan to value ratio (LVR)) drives the maximum loan, it remains unclear whether the calculation used by Centrelink is in line with ASIC’s guidelines on LVRs, which acts to protect the client from drawing on too much equity. In addition, the government reserves the right to change the calculation at any time.

Costs associated with the Centrelink PLS

The loan recipient is responsible for costs associated with:

  • title search
  • legal costs of placing a charge/caveat on the property offered as security
  • incidental costs associated with the jurisdiction’s requirements
  • the cost of removing caveat, only if the participant requests substitution of security.

The government meets the costs of:

  • property valuation
  • legal costs of caveat removal during debt discharge or property settlement
  • staff processing overheads.

Compound interest of 5.25% is charged on the balance of the loan and calculated on a fortnightly basis. The interest rate is set by the Minister for Social Services and is not benchmarked to the cash or bank bill rate. At the conclusion of the loan – when the retiree permanently leaves the home – the government collects the debt.

 

 

It is not yet clear how the revised Centrelink PLS will interact with the account-based superannuation system or meet a wider range of retiree needs. The most significant positive outcome of the policy announcement to date has been the high-level recognition that home equity is the fourth pillar of retirement funding and plays an important role in Australia’s retirement system.

The Centrelink PLS versus the rest

Improving income may be high on list of priorities for many retirees. However, there are other important needs that may need to be met – after all, needs in retirement are varied and can be unpredictable.

A large number of retirement needs require capital, not just income.

Consider the growing number of Australians retiring with mortgage debt. As well as causing financial stress, regular repayments erode retirement income. Banks have turned their backs on retirees, frequently changing the terms of mortgage agreements – such as transferring interest only loans to principal and interest loans – which result in financial hardship.

Then there are those who need capital to renovate or modify their home to make it safe and comfortable for their retirement. It might be a new roof to keep them warm and dry, or a ramp and stair-rails to enhance safety for aged living.

Other retirees need to cover large medical expenses and in-home care requirements while waiting for a government-funded package. Many simply like the peace of mind that comes from having a ‘rainy day’ fund set aside, something to cover unexpected expenses. Add to that, no one knows exactly how long they’ll live and how many years of living they need to fund.

Importantly, retirees need to look forward to their aged care needs. A refundable accommodation deposit is often upward of $500,000 – something an Age Pension, even with the Centrelink PLS, won’t cover.

Figure five compares the Centrelink PLS with an alternative equity release scheme; in this instance, a Household Loan (reverse mortgage) is used to illustrate the difference between the two approaches.

 

 

Case studies: Using home equity to improve retirement funding

Case study one: Improving income for a single age pensioner[2]

Janet is 70 and has a house valued at $500,000. She receives a full Age Pension of $926.20 per fortnight ($24,081 per year). Under the expanded Pension Loans Scheme, she is able to access some of the value in her home.

Janet chooses to receive additional funds of around $12,040.50 in the first year. Her income increases to $1389.29 per fortnight ($36,121.50 per year) – 150 per cent of the maximum rate of the Age Pension. The value of the loan funds increases over time in line with the indexation of the pension. Janet continues to receive additional funds through the Centrelink PLS for 20 years at an interest rate of 5.25 per cent.

Janet passes away at age 90. Her family sells her house for $950,000. The Centrelink PLS loan owed to the Government is around $600,000, which is paid from the sale of the house and around $350,000 remains in her estate. Over the 20 years, Janet received around $350,000 in additional income.

Case study two: Improving income for a pensioner couple[3]

Bob and Sue are a 70 year old maximum rate pensioner couple, with a house valued at $850,000. Their combined Age Pension income is currently $1,368.20 per fortnight or $35,573 per year.

Under the expanded Centrelink PLS, Bob and Sue are now able to access some of the value in their home. They choose to receive $2,052 per fortnight ($53,360 per year), the full amount of 150 per cent of the maximum rate of the Age Pension. The value of the income stream increases over time in line with pension indexation.

Over the next 20 years, Bob and Sue receive a Centrelink PLS income stream at an interest rate of 5.25 per cent. After 20 years, they sell the house for $1.6 million. While the balance of the Centrelink PLS loan owed to the Government has grown to around $900,000, Bob and Sue pay out this balance from the sale proceeds and retain $700,000.

Over the 20 years, Bob and Sue receive around $500,000 in additional income to support their standard of living in retirement.

Case study three: Home renovations

Judy and Michael are both 67 years old and live in Keilor, Victoria. They want to remain in their family home, continue their active lifestyle, and regularly bring together their extended family of children and grandchildren.

They need to invest in home renovations to make sure the home is suitable for all phases of their retirement: their home needs a new roof and both bathrooms need modifications to allow for Judy’s mobility, which has been affected by arthritis.

Drawing on home equity can be preferable to downsizing, depleting retirement savings, or endeavouring to service a home or personal loan.

Judy and Michael have a combined super balance of $330,000 and their home is valued at $750,000. They plan to remain in their home for at least another 15 years.

By borrowing $75,000 to renovate their home, Judy and Michael are able to appropriately modify their home for their current and future needs. Renovating the home also improves the capital value of the home, which continues to appreciate during their retirement years and reduces ongoing maintenance costs. It also improves the couple’s wellbeing and quality of life and increases their residual equity.

Using a Household Loan to renovate their home, Judy and Michael retain their access to their Age Pension entitlements and don’t deplete their super. Because the PLS provides only an income stream, Judy and Michael would have been unable to use it for capital expenses.

Case study four: Bridge to retirement

John is 62 years old and lives in Adamstown, NSW. He injured his back at work and can no longer continue his manual work.

John has a super balance of $37,659 and his home in Adamstown has value of $555,000. He needs an income strategy while he’s unable to work and not eligible for the Age Pension – and, by extension, the PLS.

Using a Household Loan to access his home equity, John can transfer $48,000 to his super account to create an improved income of approximately $20,000 for the next six years. Alternatively, he can create a drawdown plan of $20,000 per year for the next six years, directly from his home.

Importantly, at age 67, when can access the Age Pension, he still has 90% of his home equity remaining and can use it – whether via the PLS or an alternative strategy – to improve his income.

At any point if John has capacity he can repay the loan. Alternatively, if he keeps the facility in place until age 80 (without drawing further equity), he’s likely to have 84% of his equity remaining.

Case study five: Transition to aged care

Barbara and Paul, aged 82, have lived in their family home in Kew, Victoria since they were married. They raised their family in the home and many happy memories have been created there.

Declining health means Paul now needs to move into an aged care facility, while Barbara wants to continue living in the family home as long as she is able. If Barbara and Paul’s situation requires them to self-fund the care, one way to pay is via a Refundable Accommodation Deposit (RAD).

Barbara and Paul’s home is valued at $1.95m; at age 82 their available equity is $720,000.

They use a Household Loan to fund the provision of a $450,000 aged care RAD for Paul’s aged care, leaving $1,500,000 in residual equity in the home, including $270,000 of available equity. This allows Paul to be accommodated in a facility of his choice, close to his home so Barbara can regularly visit.

The remaining available home equity can be used to support Barbara’s life choices during and after Paul’s time in aged care. The RAD will be returned upon Paul’s death and can be used to repay the outstanding loan, be bequeathed to family or consumed.

Australian retirees really value their pension and they really want to stay at home. Retirees have a wide range of needs and while the Centrelink PLS will work for some people, it won’t meet all retirees’ needs. The Centrelink PLS doesn’t provide the capital many retirees need to live well at home or plan ahead to aged care.

By drawing on multiple sources of income, Australian retirees can live comfortably throughout 25-plus years of retirement. A long term plan incorporating the responsible use of home equity can provide for all their needs – income, housing, contingency funding and aged care – and enable older Australians to enjoy the retirement they deserve; after all, it’s their money and they worked hard over many years to earn it.

 

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[1] AIST – Expenditure Patterns in Retirement, August 2016
[2] PLS case studies are sourced from Budget 2018-19 fact sheet: expansion of the Pension Loans Scheme
[3] Ibid

 

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