There has been a lot of focus recently on retirement funding, across topics such as growing age pension payments, longevity, retirement age and costs of living. It is surprising not to hear more on the role that home equity could play in funding the retirement of senior Australians who own their homes.
Intergenerational wealth transfer
The family home is not just a place to live but also a store of wealth. The wealth could be released by simply selling the home, but this creates the problem of where to live. Downsizing is an option that might work for some people. Alternatively there are products which facilitate the separation of the ‘place to live’ and ‘store of wealth’ attributes. The most well-known home equity release product today is a debt product, known in Australia as a reverse mortgage. There are also equity products which involve selling a fixed share of the future sale proceeds of the home.
Our retirement income system is generally viewed as comprising three pillars: the age pension, compulsory superannuation and voluntary savings (including non-compulsory superannuation). Home equity represents a substantial additional pool of savings, and could be viewed as a fourth pillar of retirement funding.
Australian residential property assets have been estimated recently at $5 trillion, around triple the market capitalisation of the ASX. Housing wealth dominates retiree household wealth due to more than 85% of Australians aged 75 and over owning their homes. Substantial levels of housing wealth are bequeathed with annual intergenerational transfer of housing wealth projected at $20 billion in 2014, rising to $35 billion in 2025.
Borrowing to buy a home is effectively buying a large asset ‘brick by brick’ with the principal component of each mortgage repayment. Ideally, a home could be sold in the same way, to provide financial support in retirement. Home equity release products effectively facilitate this.
Retirees might release home equity for reasons such as unplanned medical expenses, home modification, a new car, in-home care services or simply to supplement income to fund a more comfortable retirement. Imagine the difference for some retirees if they could access their home equity to provide them with, say, $10,000 - $20,000 each year for the rest of their lives, rather than living on just the age pension then bequeathing their home when they die.
Tapping into home equity to fund retirement also provides a societal benefit, improving intergenerational equity, or fairness between older and younger generations of society.
The current system, where each generation funds the age pension costs of the previous generation, is breaking down because people are living longer in retirement, ratios of workers to retirees are falling, and the age pension is not well targeted.
The family home is fully exempt from the age pension assets test. This provides a disincentive to unlock housing wealth to fund retirement and worsens intergenerational equity. Many of those bequeathing wealth will have received a part or full age pension, and the benefits that come with that, during retirement. Intergenerational wealth transfer is generally not taxed (other than a tax on some components of inherited superannuation).
Changing public policy on housing wealth
Better targeting of the age pension would increase the likelihood that government can afford to pay pensions at adequate levels to those retirees with no other sources of financial support. Targeting should consider a retiree’s full wealth and means of financial support, including housing wealth. Removing all or part of the family home exemption from the age pension assets test would be politically sensitive - many voters view the age pension as an entitlement, not a safety net, and today around 80% of retirees access either a full or part age pension.
Critical in any change to the assets test is good public policy to avoid unintended adverse consequences. Senior Australians should not be forced to sell their homes. There would be a risk of this if the exemption were simply removed and the private sector did not step in to provide universally available home equity release solutions. Public policy must consider the availability and design of products on offer.
The home equity release market today is small. There are challenges on the demand side for a range of reasons including emotive issues relating to the family home, a lack of product providers and no promotion of the concept by government. The main challenges on the supply side are around capacity.
The November 2013 report by the Grattan Institute entitled “Balancing Budgets: tough choices we need” put forward one approach to utilising home equity to help fund retirement. It involves including the family home in the assets test but mitigating the impact on low-income retirees with high-value houses by allowing them to claim the pension and then repay the value of the pension drawn when the house is eventually sold. It is estimated that this would improve the budget by $7 billion per annum, without undesirable social consequences.
The issue was also touched on earlier this year when the Commission of Audit proposed capping the extent to which the family home is exempt from the age pension assets test, but interest in the topic waned when government rejected this proposal.
Retirement funding should be considered more holistically than it is today. There will be challenges in utilising home equity release and creating a framework that is fair. But as our population ages and our fiscal challenges continue, we must create mechanisms such as home equity release which become a meaningful fourth pillar of retirement funding.
Christine Brownfield is an actuary with 20 years’ experience in life insurance and wealth management, and is currently working at Homesafe Solutions, a provider of home equity release products.