Financial Insights with Australian Unity
Accessing home equity to generate retirement income.Posted: August 28, 2020
Accessing home equity to generate retirement income
Author: Yvonne Chu, Head of Technical Services and Professional Development, Australian Unity
Retirees with minimal retirement savings and an unencumbered family home may see unlocking equity from their principal residence as the only way to generate additional income for a comfortable retirement. Common ways to access equity in the family home include selling the property or using an equity release product i.e. a reverse mortgage. However, a commercial reverse mortgage can have high costs including the interest rate, upfront/ongoing and exit fees. As an alternative to a commercial reverse mortgage, clients may wish to consider the Pension Loan Scheme (PLS), the Government’s version of a reverse mortgage.
In this article, we provide insight on how these two strategies compare – downsizing the home and using surplus proceeds to generate a retirement income stream via the superannuation system versus retaining the home and generate income via the PLS.
Strategy one: Downsize to a cheaper home and make a downsizer contribution
A client aged 65 and over who meets the eligibility requirements can choose to make a downsizer contribution into their superannuation of up to $300,000 (for each member of a couple) from the proceeds of selling their home. To qualify a client or their spouse must have owned the property for more than 10 years and be able to claim at least a partial capital gains tax (CGT) main residence exemption on the disposal unless acquired pre-CGT (please refer to the ATO website for a detailed explanation of the eligibility rules).
Once downsizer contributions have been made, clients can use the amount to commence an account-based pension (ABP) provided it does not cause them to exceed the $1.6 million transfer balance cap.
An ABP is flexible and tax efficient, as lump sums can generally be withdrawn from the product at any time and both the pension payments and earnings on assets supporting the income stream are tax free. One of the downsides of this product is that ABPs are means tested by Centrelink and likely to reduce a client’s Age Pension entitlement.
Strategy two: Pension Loan Scheme
Under the PLS, eligible pensioners can choose to top-up their fortnightly Centrelink pension by up to 1.5 times the maximum rate of Age Pension (including any relevant supplements) and can improve their standard of living. For example, a couple receiving the maximum rate of Age Pension (currently $37,013.60 p.a. as at 1 July 2020) can increase their entitlement to $55,520.40 p.a. which is close to 90% of what a couple aged around 65 will require to live a comfortable retirement lifestyle according to the ASFA Retirement Standard1.
A big advantage of the PLS is that it is a relatively simple Government administered scheme providing additional fortnightly income. It can be stopped and adjusted at any time (subject to repayment of the outstanding loan) and the interest rate (currently 4.5% p.a.) is generally lower than interest rates offered on commercial reverse mortgage products.
The PLS can help clients avoid the need to sell a property when market conditions are unfavourable and it can provide additional income for clients who receive a reduced rate of Age Pension; for example, clients living on a farm with acreage in excess of 2 hectares whereby the assessment of excess land reduces or eliminates their Age Pension entitlement.
The additional Age Pension amount accrues a debt due to the Commonwealth and is secured against a nominated property. The debt is subject to compound interest rate (4.5% p.a. commencing from 1 January 2020) applied fortnightly.
A maximum loan amount applies and when reached, PLS payments will cease and interest will continue to accrue until the loan is repaid. The maximum loan amount is not fixed and is recalculated every 12 months in January or July, following a person’s birthday to adjust for the higher age component available. The maximum loan amount is determined based on a set formula depending on various factors including the amount of equity held in the property and the age of the applicant. Refer to the Guide to Social Security Law 184.108.40.206 for formula and age component amounts.
All or part of the debt can be repaid at any time however this usually occurs after the property is sold.
Words of caution for PLS
Like a commercial reverse mortgage, it is imperative for anyone considering the PLS to understand the effect of compound interest on the outstanding debt. The total accrued interest can be very substantial as the outstanding loan amount is generally repaid many years after commencement, usually on death of the client. For example, a single pensioner on the full Age Pension who borrows an additional 50% of the Age Pension (approx. $12,567 p.a. indexed to 4% p.a.) under the PLS will accrue a debt of approximately $178,916 after 10 years, $326,656 after 15 years and $530,230 after 20 years. This could have a significant impact on the amount of assets that is ultimately left to the estate of a client.
When accessing the PLS, clients should also note any impact for aged care purposes. While the fortnightly top-up amounts under the PLS are not assessable for aged care purposes, the accrued debt against real property used as security reduces available assets that can be used to pay accommodation or ongoing aged care costs. Where a resident is required to pay an agreed advertised price upon entering a residential aged care facility, the amount which has not been paid as a lump sum is used to calculate an ongoing accommodation cost payable by the resident based on the prevailing interest rate.
Please contact your adviser if you wish to discuss this further. This article was first published in Money Management.
1 According to the Association of Superannuation Funds Australia Retirement Standard, March quarter 2020, for a couple aged 65 the amount of income required for a comfortable retirement lifestyle is $62,435 pa.
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