Your home: The foundation of retirement planning

This begs the question: How and when can these savings be withdrawn?

One home many functions

A family home that is fully paid for or close to it when you retire provides more than a roof over your head.  It is also:

• A store of tax-free wealth, as the family home is not subject to capital gains tax when sold.
• A way of maximising Age Pension entitlements as it is not included in the assets or income tests.
• A potential way of financing residential aged care.
• A future bequest to your children.

When you think about your family home that way, it is more like the cornerstone of your retirement plan than a decorative plinth as it underpins all three pillars.

In Australia, for the reasons listed above, the tax treatment of the family home leads to a perverse incentive to own outright the biggest, most expensive home you can afford as you head into retirement.

For all the talk of super, most Australians enter retirement with more wealth in their home than their super.

Asset rich, income poor

Australian retirees are some of the wealthiest in the world, with median household wealth of around $1.4 million. Yet close to $1 million of this wealth is tied up in the family home.

That’s partly because today’s retirees – especially women and anyone with a broken work history – haven’t had the full benefit of compulsory super to sustain a comfortable standard of living in retirement. However, they do have relatively high levels of home ownership.

Around 75% of retirees own their home, including 1.8 million seniors on the Age Pension. According to the Grattan Institute, home ownership among retirees is on course to drop to 57% by 2056, which will create a new set of challenges, although future generations of retirees will have more super.

Hazel Bateman of the UNSW ARC Centre for Population Aging and Research said Australian homeowners aged between 60 and 80 had 10.5% of their assets in super in 2020, over 61% in housing and 28% in other financial assets.

Yet the focus of retirement planning is fixed on super. Go figure.

Super gap is closing too slowly for some

According to Treasury estimates, around 65% of super account balances at retirement were less than $250,000 in 2020. While that percentage is set to drop to 35% by 2040, that’s small cheer for today’s retirees living on a full Age Pension topped up with a little income from super.

At the upper end of the scale, 10% of today’s retirees have more than $750,000, which should rise to 15% in 20 years. This group is likely to have a home and other resources to fund a comfortable retirement lifestyle.

The percentage in the middle with $250,000 to $750,000 will double from around 25% now to 50% by 2040.

For this middle group, retirement planning is complex according to Andrew Boal, a partner at Deloitte. He says most will receive a part Age Pension as their super runs low, but they face complex income and assets tests depending on whether they own a home or have a partner.

Boal says this middle group may need to access their home equity to fund the retirement lifestyle they aspire to. However, many are reluctant to downsize or take out a reverse mortgage in case they need their home to fund aged care if their health deteriorates.

This is borne out by the fact that most retirees die with around 30% of their super intact. Yet many retirees will have lived more frugally than they need to, often in a home that becomes a source of worry as much as a comfort when they can no longer afford to maintain it or pay for help mowing the lawns and cleaning.

No such thing as a standard retirement

Using the ASFA Retirement Standard as a guide, a combination of income from super and the Age Pension is generally enough to provide income for regular household expenses.

According to ASFA’s sample household budgets, the annual income needed for a comfortable retirement is currently set at around $70,000 for couples and $46,000 for singles. That’s significantly higher than the Age Pension, which is currently set at around $43,000 for couples and $28,500 for singles.

But what happens if you need to replace your car, repair the roof, pay hefty out-of-pocket medical expenses or fund aged care either in the home or a residential facility?

Studies have shown that most people use a form of mental accounting that sets aside super for income, other financial assets for emergencies or precautionary saving and the family home for bequests.

Bob Officer, professor emeritus at the University of Melbourne and chairman of Acorn Capital says it makes no sense to live like a pauper to hang onto your home, especially for retirees without children or dependents. And now that we are living longer, the ‘kids’ are often in their 60s by the time they inherit and no longer need help. Or at least, they may not need the full value of the family home.

For these reasons, there is growing interest from retirees and the government in financial products that allow retirees to tap into their home equity.

Unlocking housing wealth

For historic reasons, reverse mortgages have not gained much traction in Australia. But that’s slowly changing, following tighter regulation (see Tighter regulation of reverse mortgages below) and the impact of low interest rates and low economic growth on retirement incomes.

So, what are they and how do they work?

Reverse mortgage

Because of the negative connotations of the name, many providers prefer to call their product ‘equity release’ or ‘home equity’ schemes. A reverse mortgage allows you to borrow money against the equity you have built up in your home, that is, the value of your home less any mortgage debt outstanding. Drawdowns can be taken as a lump sum, income stream, line of credit or combination of these.

Interest is charged like a normal mortgage but, rather than pay as you go, all interest is added to the initial loan and repaid when you sell, or by your estate on your death. Reverse mortgage interest rates are generally up to 2% higher than standard variable mortgage rates. Current interest rates charged by commercial reverse mortgage providers range from 7.4% to more than 9%. You retain ownership of your home and can live there as long as you like. There are caps on the amount of equity you can withdraw, depending on your age, and you can never end up owing more than the value of your home.

The Home Equity Access Scheme (formerly Pension Loans Scheme)

The HEAS is a reverse mortgage offered by the federal government via Centrelink, but it too prefers a more benign-sounding name. It allows Australian citizens/residents of Age Pension age (67 now and for the foreseeable future) and older who own freehold property anywhere in Australia to receive a tax-free fortnightly income stream by taking out a loan against the equity in their home. Since 1 July 2022 borrowers can also access lump sum advances. The current interest rate of 3.95% is significantly lower than commercial rates.

Tighter regulation of reverse mortgages

Reverse mortgages have long suffered from an image problem among consumers who tended to dismiss them as high risk and potentially dangerous, often for good reason. While there are still risks, the regulation of these products is much improved.

There are now consumer protection laws specific to these products as well as general consumer protection laws.

Some of the main consumer protections are:

• A no negative equity guarantee since 2012, which means borrowers can’t end up owing more to the lender than the value of their home when it’s sold
• Borrowers can remain in their home until they die or decide to move
• Lenders must give borrowers projections of the home equity taken using ASIC’s Moneysmart Reverse Mortgage Calculator
• Reverse mortgages are covered by laws that prohibit unfair contract terms
• Product providers must be licensed and a member of the Australian Financial Complaints Authority (AFCA), which can hear consumers’ complaints for free.

Growing awareness of equity release

Although the HEAS has been operating since 1985, the take-up was low because few people knew about it. But an extension of the eligibility criteria in July 2019 and the ability to withdraw lump sums from July 2022 has resulted in a jump in participants to 9750 in the 2023 financial year compared with less than 800 four years earlier.

Demand and awareness have increased recently due to a convergence of factors. Super balances are volatile with a lower growth outlook, while rising inflation means retirees are feeling the pinch of a cost-of-living crisis.

This has made retirees cautious about spending and more proactive about seeking new sources of income.

Also bubbling away in the background, the impact of COVID and the horror stories emerging from the Aged Care Royal Commission have made older Australians more determined to ‘age in place’. A survey conducted for Household Capital in October 2020 found 73% of homeowners over age 60 wish to remain in their own home and view it as the safest place to be.

So how are retirees tapping into their home equity and what strategies are available?

Strategies for home equity release

Josh Funder, chief executive of reverse mortgage provider Household Capital, says retirees are using equity release for a variety of reasons, including:

• Topping up retirement income and investments
• Refinancing bank debt
• Home renovation
• Helping the kids and grandkids
• A combination of the above.

If you wish to continue living in your home for as long as possible, Funder says drawing income from your home equity should be viewed as part of your long-term retirement income plan, rather than a solution to urgent short-term needs.

Professor Officer thinks home equity release could provide a valuable source of income for asset-rich, income-poor retirees, but he stresses it is not for everyone. Some people will be better off in aged care late in life, rather than struggling in their own home.

He says home equity release is most likely to be attractive for retirees in their 70s, sitting in an expensive house but with a dwindling super balance and a life expectancy of 10 years or more.

Missing links in retirement income system

While the framework and products are already in place to allow retirees to tap into their home equity, there is still a lack of cohesion between the three pillars of our retirement income system.

Professor Officer would like retirees to be able to roll equity release funds into super without it being included in the Age Pension assets test.

After age 74 it is generally not possible to put any more money into super if you’re no longer working. One exception is making downsizer contributions if you sell your home, and some argue there is a case for treating equity release contributions in a similar way.

The Retirement Income Review suggested that including the home in the Age Pension assets test (it is excluded now) might tempt more retirees to access the equity in their home to help fund their retirement. While that would be an equitable solution – putting homeowners on a more even playing field with renters – it would face fierce opposition.

Unpalatable options aside, greater flexibility can’t come fast enough for many retirees currently dealing with declining income.

The bottom line

The family home is often overlooked as a potential source of funds in retirement as well as being a roof over your head. But awareness is growing as retirees search for ways to boost their income in the face of low investment returns and an Age Pension that is not increasing as much as most would wish.

Home equity products have come a long way and those on offer in Australia are now highly regulated. If you are considering drawing funds from your home equity, it needs to be viewed as part of your overall retirement income plan. You should also consider seeking independent financial advice.