Until recently, housing wealth has been largely inaccessible to fund retirement needs.

After two years of living with the threat of COVID, its real and potential impacts on health and finances, in and out of lockdown, older Australian understand more than ever the value of the family home as a safe haven and the preferred place to live during retirement.

During the same period, house prices have appreciated around 22 percent^[1], which means the value of home equity saved in the family home is now worth three-to-four times average superannuation savings.

Until recently, this wealth has been largely inaccessible to fund retirement needs. Given that so many retirees wish to stay in their own home as they age, a fact compounded by the Royal Commission into Aged Care Quality and Safety, as well as the COVID issues that have plagued the sector, this untapped savings is a valuable resource. It’s a resource that can be used to provide improved retirement funding and cover important costs such as age-appropriate in-home care and home renovations to allow retirees to live safely and comfortably at home.

There are a number of strategies financial advisers can utilise when it comes to using home equity. Rather than simply drawing a lump sum, it can be incorporated into a financial strategy to improve retirement income, to top up depleted retirement savings or to preserve income producing assets when capital requirements need to be met.

Home equity: simple ‘three pillars’ retirement strategies

In its Retirement Income Review, the federal government talked about three pillars of retirement funding: superannuation, the Age Pension and voluntary savings. That latter category – or third pillar – includes home equity. This is because for many Australians, the ‘savings’ or investment in their family home represents their largest store of wealth.

Accessing home equity effectively addresses retirement income adequacy and sustainability for most retirees. In addition, the use of home equity can mitigate key risks – sequence and longevity risk – through diversification of income sources during negative market conditions.

Coordinated strategies provide the framework for responsible access to home equity, and ensures sufficient access remains available for future options. Such strategies can also increase the longevity of super savings. Each of the following will be examined in greater detail.

Strategy one: Basic layering to improve income adequacy

Adding a layer of home equity retirement funding to superannuation and Age Pension entitlements can boost retirement income to a ‘comfortable’ level. This can be implemented by a variation on the traditional ‘4% rule’.

In the early 1990s, William Bengen was the first to propose that drawing 4% of savings at retirement each year would improve the chances that those savings would last 30 years. Around the world, variations of the 4% rule of thumb have often been used as the ‘safe withdrawal rate’ to ensure pension sustainability.

Since then two major changes have challenged the ability of the 4% rule to generate a sustainable retirement income: longevity has increased significantly over the past 30 years and we are now facing     a lower growth environment, with persistent low interest rates, volatile dividends and what is likely to be subdued portfolio appreciation.

Combined, these two major challenges reduce the probability that retirees can be successful in making retirement savings last over 30 years.

The 4% rule – and its shortcomings – are best illustrated using a case study.

Let’s use the example of a retired couple, both 67 years of age with $250,000 in superannuation and  a wholly owned home valued at $750,000 home trying to fund their retirement. The new reality of the long term, low growth outlook they face is:

• 5% pa returns on superannuation growth
• 75% pa paid in fees to manage their investments
• 6% pa investment.

At the same time:

• house price growth is 3% long term
• estimated house price volatility of 3.5%
• cost to access home equity 5% per annum
• long-term inflation is 3%.

How can they navigate the next 30 years?

Using the 4% rule sees the couple’s retirement savings run out well before their expected longevity. But the biggest problem with the 4% rule is that it’s focused on sustainability and does not address retirement funding adequacy.

In this 4% drawdown example, the couple were forced to live on a retirement income consistently well below the ASFA’s ‘comfortable’ standard and the surviving partner lived on the pension alone for their last seven years. The 4% drawdown rule generates little flexibility to maintain a quality lifestyle, manage unanticipated expenses like healthcare, in-home care or aged care, or even to fund and enjoy extended longevity.

A new approach: 3+1% drawdown

Australian retirees are among the wealthiest in the world; household wealth rose $590.0b (4.4%) to a record $13,918.5b in September 2021^[2] Despite this perceived wealth, the majority of it is tied up in the family home where most older Australians want to live throughout their retirement.

Instead of the 4% drawdown rule of thumb, to get through retirement with confidence, Australian retirees could adopt a 3+1% drawdown rule: 3% of the value of their investments at retirement per year plus 1% of the value of their home equity per year.

Adding an additional 1% per annum draw down from home equity, the couple discussed in the case study could begin to achieve a retirement income that is both sustainable over more than 30 years and adequate relative to comfortable lifestyle standards.

Using a 3+1% retirement drawdown approach is a layering strategy that provides our couple with the flexibility to draw additional funds along the way if they need to renovate the home, meet unexpected expenses, if they live longer than anticipated or they choose to give to their children and grandchildren before they die.

The 3+1% rule of thumb has several major implications for Australian retirement funding:

• 3+1% provides a sustainable, adequate retirement funding plan for the majority of Australian retirees
• 3+1% would improve retirement outcomes, lifestyle and wellbeing
• 3+1% diversifies retirees’ sources of retirement funding and improves the probability they will successfully fund their full longevity.
• 3+1% preserves significant savings for retirees to be the bank of mum and dad and to bequeath to the next generation without unduly depleting available retirement funding
• 3+1% supports age-appropriate housing for in-home ageing at all stages of retirement for couples and surviving partners
• 3+1% maintains a significant reserve of value to fund in-home care and residential aged care
• 3+1% would boost retiree consumption and provide a long-term stimulus to the local economy
• 3+1% brings $1trillion of retirees’ savings to bear on funding their own retirement without including the home in the assets test for the pension or imposing a death tax to recoup the costs of aged care services.

Strategy two: Top up depleted savings

Based on tax and census data, the median household in Australia has $200,000 in superannuation at retirement. While it is acknowledged that ‘advised’ Australians are likely to have larger super balances, for many, even a larger super balance does not last for 20 plus years in retirement. Add to that the propensity for retiring Australians to draw a lump sum from their super to pay out mortgages or other debts, or to make substantial purchases (new car, caravan, extensive holidays), it’s not uncommon for Australian retirees to face depleted retirement savings.

While the Age Pension is there as a safety net, it’s not sufficient to provide more than a basic lifestyle.

Home equity can replace pension income from a depleted super fund and can be used to restore or preserve income levels.

At 75 years old, clients can responsibly access up to 30% of their home equity. A top up to ‘at retirement’ income levels can extend retirement income for 10+ years and leave 85% of home equity available for other needs, such as funding in-home care or residential aged care.

Case study: Funding clients’ parents

Back story

A North Sydney based adviser shared the story of one his clients, a story he sees played out time and time again. In this case, his clients – let’s call them Peter and Jill – were aged in their 50s and trying to get their finances prepared for retirement. However, they had two issues: the couple was still paying for private education and were also funding Jill’s parents who live on Sydney’s northern beaches.

The problem to be solved

Aged in their early 80s, Jill’s parents live an active lifestyle, which throughout their 60s and 70s had included plenty of travel. They have now depleted their retirement savings and live solely on the Age Pension. As a result, they rely heavily on Jill and Peter to help them maintain their home and cover major expenses. Their home is valued at $4.6 million…a home they purchased for less than $100,000.

How using home equity helped

Peter and Jill’s adviser worked with his clients and Jill’s parents to establish a retirement funding plan that included drawing on their substantial home equity. Jill’s parents used their home equity to establish a regular fortnightly income stream, to supplement their Age Pension. Because home equity does not form part of Centrelink’s income test, this would not impact their pension entitlements.

They also drew a lump sum from their home equity to repay their borrowings from Jill and Peter, and to undertake some home modifications so they could continue living safely and comfortably in their family home.

Strategy three: Fund unexpected expenses

As well increasing costs when it comes to day to day living, retirees can often face unexpected and unbudgeted expenses. When living on an income is fixed at a rate to make it last across many years of retirement, finding necessary capital can be difficult and since the 2018 royal commission, banks are much less likely to extend credit to retirees.

It may be:

• to replace an ageing or unreliable car
• to purchase a modified vehicle to deal with physical limitations
• to undertake necessary home repairs or modifications
• to cover medical or dental bills
• paying off existing debt that eats into monthly income streams.

Retirees like the peace of mind that comes from having a contingency fund to draw on in the case of unexpected expenses. Using home equity, a contingency fund can be established but not drawn; this means it’s there when it’s needed, but interest doesn’t accrue until it is drawn.

Case study: Lifetime defined pension, but no access to capital

Back story

Michael lives alone in Brisbane’s northern suburbs and has two children who are his beneficiaries. He receives an indexed lifetime pension from the Australian Defence Forces that comfortably covers his income requirements. Unfortunately however, this defined benefit pension cannot provide capital when required.

The problem to be solved

Michael had some capital requirements he was unable to meet from his pension. His home needed some repairs, including replacement of his roof and guttering. He also needed to pay out a small residual mortgage and wanted more flexibility with his repayments.

He also wanted a new car to tow his caravan, as he does a lot of travel and camping. Michael also wanted access to a contingency sum for any other large expenses that may arise over the coming years.

How using home equity helped

Michael drew home equity to the value of $192,500, which was allocated as follows:

• $48,000 for a new vehicle
• $33,000 to refinance his existing mortgage
• $30,000 for maintenance and repairs to the house
• $80,550 for a contingency fund for other capital items as required over the coming years

Michael has now refinanced his mortgage, completed the home repairs and has purchased a new car. He has approval for the contingency funds if and when he needs them in the future. He will not pay any interest on these funds unless they are drawn down.

Retirement should be an exciting phase of life rather than one approached with trepidation and fear of outliving retirement savings. Including home equity in the retirement funding mix allows us to deliver retirees’ wealth back to them and restore confidence in their future. Australian retirees enjoy some of the lowest home equity interest rates in the world and benefit from the world’s best practice regulatory protections.

Retirees need flexible access to income and capital, now and in the future. This could be a lump sum, a monthly, quarterly or annual income stream, a cash reserve or a combination of all three. By using home equity, this is possible irrespective of the client’s level of super.

Australian retirees are the wealthiest in the world – working together we can deliver that wealth back  to our seniors, make retirement a fantastic phase of life, and lead the world in meeting the challenges of an ageing population.

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[1] https://www.corelogic.com.au/news/housing-values-end-year-221-higher-pace-gains-continuing-soften-multi-speed-conditions-emerge
[2] Australian National Accounts: Finance and Wealth, ABS, September 2021

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