Five ways home equity can improve their clients’ retirement funding requirements and improve their outlook.
Retirees are worried. And while that may be a generalisation, for many older Australians, it’s also reality. Inflation is rising during a period of persistently low interest rates, meaning each dollar buys less. When you’re living on a fixed income, that scenario is especially challenging.
The recent Household Capital/Your Life Choices Retirement Confidence Survey elicited responses from nearly 5,000 retirees. It found the areas of greatest concern to be the impact of inflation and ongoing low interest rates. Of less concern was volatility in the property market or changes to the government’s deeming rate.
Of greater concern was the 68 percent who were concerned or very concerned about not being able to afford to meet their long term care expenses. A similar number of respondents said their retirement income is not keeping up with the cost of living and 65 percent were concerned or very concerned they are unable to maintain a comfortable retirement.
Given the uncertainty in the current environment, how can you give your clients the confidence to look forward and enjoy their retirement years?
In our last article we examined three strategies you can utilise for your clients 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.
In this article, the focus is on the purposes for which those strategies might be implemented.
Home equity retirement funding
Although many retirees have been hurt by continued low interest rates, during the same period, house prices have appreciated enormously, with a rise of around 22 percent[1] in the past year alone. This means the value of home equity saved in the family home is now worth three-to-four times average superannuation savings.
However, this wealth is locked away and has been largely inaccessible to fund retirement needs. Given that most retirees wish to stay in their own home as they age, this untapped savings is a valuable 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.
The alternative to using home equity to meet capital needs is usually for retirees to draw on their income producing assets and risk running out of money later in life. Or they simply go without.
Retirees can draw on a portion of their home equity to receive a monthly or fortnightly income stream, to live a comfortable retirement lifestyle without having to be concerned about every dollar spent. Home equity can also be drawn as a lump sum – or a mix of capital and income. Access to capital is important…most older Australians are generally unable to access credit facilities via their bank and can often face substantial costs to repair or modify their home or meet medical expenses.
Purpose led funding
Australia’s retirees are not a homogenous cohort. While there may be some commonalities among them, their needs and aspirations are diverse. In dealing with adviser’s retiree clients, it has been our observation that most retirees need to improve their retirement funding to achieve several purposes or goals.
Generating retirement income
When analysing the data from the Household Capital/Your Life Choices Retirement Confidence Survey, it wasn’t surprising to see nearly 60 percent of the least wealthy cohort was very concerned about retirement income not keeping up with expenses. However, what was surprising was the same level of concern being expressed by 30 percent of high net wealth respondents. A further 27 percent of this HNW cohort indicated they were ‘concerned’.
Many self-funded retirees have seen their income shrink; whether due to pervasive low interest rates on cash and fixed income investments, from market volatility or disrupted rental income streams, it’s also a cohort that received little benefit from this year’s federal budget.
Home equity can be used to establish a regular income stream, paid fortnightly or monthly. Income drawn from home equity can form part of an income layering strategy or supplement a reduced drawdown from superannuation or other investments. This strategy can have a disproportionate benefit relative to the modest reduction in future available equity. For example, an additional $1,000 per month can improve many retirement lifestyles, after 5 years (i.e $60,000) the client retains access to 94% of their home equity (assuming 3% house price growth).
Alternatively, capital can be drawn and used to replace income as required. However, where a client is eligible for a full or part pension, withdrawals of large sums may impact the assets test.
Case study 1: Income decimated due to Covid
Back story
Margie, aged 71, had downsized to an apartment in Brighton, one of Melbourne’s beachside suburbs, which is her ‘forever home’ and close to all the facilities she needs. She is widowed and owns a commercial property that has provided an income of $74,000 each year through her retirement to date. Consequently, she is ineligible for the Age Pension.
The problem to be solved
Covid had severely impacted the businesses that rent Margie’s commercial premises, which in turn negatively impacted her income. She has had to use her available savings to fund her day-to-day life, and her financial adviser recommended she should not sell the commercial premises. Margie required a source of income until such time as her commercial rental stream was restored.
Use of home equity
Margie used her home equity to meet her income requirements. Rather than drawing a fortnightly or monthly income stream, she chose to draw down lump sums as and when required. Margie initially drew funds in 2020; her rental income resumed for a time however, more recently, the 2021 Delta and Omicron variants adversely affected her rental income. To date she has drawn down $100,000 of her available loan facility to be able to live comfortably. Margie accrues interest only on the funds drawn.
Refinance existing debt
Average mortgage debt among older Australians has blown out by 600 per cent since the late 1980s and nearly half of all homeowners aged 55 to 64 are still paying off a mortgage, up from just 14 per cent 30 years ago[2]. As well as creating unnecessary stress, carrying a mortgage into retirement can consume a significant portion of retirement income.
It is not uncommon for the newly retired to use their superannuation balance to discharge the mortgage; however, the downside can be a significant reduction in income producing assets to provide for a comfortable retirement.
Using home equity to refinance an existing mortgage – or other debt – at retirement has three benefits:
- improved retirement funding – because your client does not have to make regular repayments, the money being used to service the mortgage can instead be used to fund their retirement
- interest payment flexibility – your client can choose to make regular interest repayments, however, there is no obligation to do so
- guaranteed occupancy – whether or not your client elects to make repayments, they have guaranteed occupancy of their home until they choose to leave it.
Case study 2: An unplanned retirement
Back story
Geoff is 66 years old and lives in McMahon Point, Sydney. He has a younger partner and two children. His house represents the majority of his wealth, recently valued at $7.6 million.
The problem to be solved
The Covid-19 pandemic forced Geoff to bring forward his retirement plans. He had planned to continue to work for several more years to pay down his mortgage, build up his retirement savings and then realise the value of his property by downsizing. Geoff had been self-employed for a good part of his early career and his superannuation balance was around $200,000 at his unplanned retirement.
Use of home equity
Geoff’s financial adviser recommended using his available home equity to refinance his $800,000 mortgage and establish an income stream for the next five years. Drawing on a small part of his home equity, Geoff was able to improve his retirement income in two ways: by no longer having to meet regular mortgage repayments and by receiving a regular fortnightly income stream.
A drawdown of capital to live
Access to capital becomes more challenging in retirement. Banks are reluctant to extend credit and most retiree’s capital is invested to produce income. A substantial drawdown from income producing assets can reduce the longevity of retirement income.
Capital needs might include:
Home renovations, modifications or maintenance
Numerous studies have found that retirees wish to ‘age at home’, to remain in their family home as long as possible. For older Australians, a familiar home improves their perception of security, helps to maintain social connections within their community, and provides access to services and proximity to family and friends. However, it’s important the home is retirement ready, safe and comfortable today and into the future, able to accommodate changing needs.
A new vehicle
A new car to ensure safety and mobility; for some a mode of transport, for others a means to travel.
Medical needs
Funding for large medical expenses for surgery, long-term treatment, dental services or other needs not covered by health funds or medicare.
Contingency funding
Many retirees like the peace of mind that comes from having a contingency fund for those unexpected expenses that arise from time to time. Whether it’s urgent repairs for the home or car, an opportunity to travel or unexpected dental work, home equity can provide a contingency fund to draw on in times of need.
When asked about confidence in having the funds available in the event of an emergency, respondent to the Household Capital/Your Life Choices Retirement Confidence Survey were not positive. Within the three highest wealth bands, around 50 percent of respondents in each group were concerned or very concerned about their ability to fund such expenses.
Case study 3: Lifetime defined pension, 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; while this adequately covers his income requirements, this pension cannot provide capital when required.
The problem to be solved
Michael had some capital needs he was unable to meet from his pension. He needed to replace his home’s roof and guttering. He also needed to pay out a small residual mortgage and wanted more flexibility with his repayments. Finally, 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.
Use of home equity
Michael drew from his home equity a sum of $192,500 that 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.
Case study 4: A major renovation
Back story
Steve 71 and Jenny 64 live in their long-term family home, valued at $1.95 million, near the beach in Sydney’s Eastern suburbs. They love the location and decided to renovate their home to make the most it. They are self-funded retirees with $800,000 invested and have no children.
The problem to be solved
The renovation was quoted at approximately $300,000. Their adviser suggested the couple use their home equity to fund the renovation rather than draw on their invested capital, because that would reduce their income over the longer term. Given they were not bequeathing assets to children, they viewed using home equity as a strategy to enable them to have the best of both worlds.
Use of home equity
Steve and Jenny used $370,000 of their home equity to pay for their renovation; the additional amount allowed for any cost overrun.
Their home has been beautifully renovated, and as a result, the value of their property has increased significantly; Core Data’s most recent estimate is $3.45 million.
Top up retirement savings
Not everyone reaches retirement with adequate retirement savings. You may have a new client seeking retirement advice, but who doesn’t have sufficient capital to generate an adequate retirement income. Another may have used a significant portion of their super to discharge a mortgage or other debt.
Home equity can be used to ‘top up’ superannuation or other income generating investments, to increase the longevity of retirement savings and ensure income adequacy for retired clients.
Case study 5: A top up to replenish retirement savings
Back story
Teresa, 61, is on a disability pension and was referred to Household Capital by an estate lawyer. Her husband passed away with an old will that required charitable donations before the estate could be settled and Teresa could inherit the home. Unfortunately, by the time her husband passed away, all investment assets had been depleted and Teresa was unable to make the bequests. Teresa loved her home and did not want to sell the house to cover estate costs. Her only daughter helped cover living costs and home maintenance during this time.
The problem to be solved
Teresa needed $100,000 to cover estate costs – bequests and legal fees – so the estate could be settled, and she could inherit the property. The home was in an excellent location, however it needed some renovations to make it safe and comfortable. Teresa also needed contingency funds to cover large expenses, including rates for the coming years. Her husband’s death meant a drop in her pension income, but no real material fall in living expenses.
Use of home equity
Teresa was able to top up her retirement funding by drawing on her home equity. It was used as follows:
- $100,000 to cover estate bequests and legal costs
- $50,000 for home renovations including updating kitchen, bathroom, flooring and paint
- $185,000 contingency fund for future large expenses – drawn as required
The estate has now settled, and Teresa inherited the house and completed the renovations. The value of the house has increased since settlement, with a Core Data estimate of $3 million.
Give when they need it most
While the surging property market is a boon for home-owning retirees, it’s not such good news for their children and grandchildren. Those clients who are well established for retirement might wish to expedite an intergenerational wealth transfer at a time their beneficiaries need it most.
Case study 6: Helping the children with a living inheritance
Back story
Michael and Judy are advised self-funded retirees with an income of $65,000 per annum generated from their investment assets. They love their home in Sydney’s northern beaches, live a great life themselves and have decided they’d like to help their children while they’re still alive to see the benefit.
The problem to be solved
They have two children, both married with small children, both of whom are equal beneficiaries of their estate. Michael and Judy want to give each of their children $250,000 to help them upgrade into larger homes. They have been advised not to sell any of their income generating investment assets to do so.
Use of home equity
Michael and Judy drew $500,000 of their home equity to gift $250,000 to each child. As a retired lawyer, Michael had organised legal agreements for these loans at it helps protect the children in the event of divorce. In addition, there are no Centrelink impacts because they are self-funded retirees.
Fund medical or aged care
As more retirees age at home, there’s increasing pressure on government funded in-home care packages. Despite increases in funding, there are currently more than 100,000 people waiting for care, and many have to accept packages providing a lower level of care than needed.
Your clients can use their home equity to cover medical or dental expenses or pay for in-home care and appoint their choice of supplier. Home equity can also be used to finance the transition to aged care, to pay the refundable accommodation deposit (RAD) or make daily accommodation payments (DAPs).
Case study 7: Funding aged care fees
Back story
Maria, 90, was referred to Household Capital by a financial adviser specialising in Aged Care Advice. With her husband already in aged care, Maria had just entered full time aged care but wished to retain her home. Maria’s three sons, each equally her enduring powers of attorney (EPOA), were undertaking the advice process on her behalf. Her sons are all in the building trade and when Maria decides she wishes to sell in the future, they would like to be able to renovate her home prior to sale. They are all equal beneficiaries of their parent’s estate.
The problem to be solved
The financial adviser had advised the sons that paying the care fees as opposed to paying a large lump sum (RAD) made more financial sense; these costs are $3,333 per month. Before the approaching Household Capital, the sons had been sharing the costs of the monthly fees. The only other alternative was to sell the property, to which Maria was opposed.
Use of home equity
Using the power of attorney, Maria’s sons arranged a Household Loan of $121,788 to cover the monthly fees of $3,333 per month for three years, with the ability to extend this timeframe as necessary. The monthly care fees are paid automatically into Maria’s account and are debited directly by the aged care provider. This gradual drawdown limits the amount of interest accumulating, because interest is only paid on drawn funds.
Conclusion
Increasing longevity suggests it’s an optimal time to include home equity as a part of retirement planning. By drawing on multiple sources of income, Australian retirees can achieve funding adequacy throughout the full course of 25+ years of retirement.
To achieve this, retirees must be able to responsibly and cost-effectively access home equity savings to meet a range of needs in retirement, to access income and capital to improve retirement funding, housing and wellbeing.
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