Five ways to use the family home for retirement income

The family home is set to become a more integral part of many people’s retirement income strategies. There are myriad reasons for this to happen but three stand out:

1. Inadequate superannuation balances

The federal government is still doing the heavy lifting in supporting most people in retirement via a part or full pension, despite Australia having compulsory superannuation for nearly 30 years. Most people will remain eligible for a pension at retirement.

It’s not hard to understand why. One of superannuation’s commonly quoted benchmarks, the ASFA Retirement Standard, maintains that for a couple to enjoy a comfortable retirement they need an annual income of $62,000. Nothing lavish, but comfortable.

That number is based on assumptions such as a couple owning their own house, but it excludes savings and investments outside super and having no other sources of income in retirement.

So how much money is needed at retirement to fund this annual income? According to SuperGuide, to earn $62,000 for 25 years, a couple’s required savings spans from $410,000 (assuming a 7% return) to $1,020,000 (assuming a 2% annual return).

With the cash rate at 0.25% and volatile markets, assumptions about investment returns should probably tend towards the more conservative end of the spectrum. But even at a generous 4%, $700,000 is required.

Yet that sum of $700,000 falls well short of the average balance at retirement, estimated to be about $450,000 for men and $375,000 for women. These people will go on to a part pension, at least. And that’s not about to change, with the Productivity Commission’s 2018 report showing an average fund member enjoying the Super Guarantee all their working lives will still fall short of this target.

These numbers were also compiled before COVID-19, and this tragic pandemic is already having an impact on its assumptions in one obvious way: the government’s decision to allow people to make early withdrawals of up $20,000 from superannuation for the 2019-20 and 2020-21 financial years. A 30-year-old who withdraws the $20,000 is sacrificing an estimated $43,000 on retirement at age 67.

2. Longevity and demographics

The flip side of superannuation balances falling short is demographics. Some couples will live longer in retirement than 25 years. In 2017, there were 3.8 million Australians aged 65 plus or 15% of the population, a figure that is projected to grow to 8.8 million by 2057.

Looked at another way, 57% of seniors were aged 65-74 in 2017 and 13% aged over 85. By 2047, 20% will be over 85, with all the fiscal ramifications that implies. This ageing population will remain fitter and healthier for longer in retirement, ensuring bigger demands on their retirement savings.

3. Fiscal limitations

The federal government’s stimulus packages to counter COVID-19 means Australia is experiencing its biggest budget deficit since World War II and future governments will need to rebuild the country’s balance sheet. It would be naïve to think that future treasurers will not cast an envious eye over the super honey pot that is approaching $3 trillion.

At the last election, Labor signalled its intention to limit the claiming of franking credits on Australian equity dividends. Although that proved politically unpalatable, the country is now in a far more fraught fiscal position. Tough times could demand tough measures.

There are at least two other tax options: increasing the headline super tax rate of 15% and reducing the capital gains concession from the current one-third. Although the latter would have minimal fiscal impact, the former could do some heavy lifting.

But robbing Peter (Australians in the accumulation phase) to pay Paul (the deficit) would come at a high cost to the former, with research showing that lifting the tax rate to 25% would cut $150,448 off the retirement savings of someone retiring at 67 on $682,146 (the Productivity Commission’s projected figure).

Five ways to use the family home for retirement income

The coalescing of these three factors suggests future governments will want the home to play a bigger role in people’s retirement income strategies. It would surprise if the pending Retirement Income Review did not take a close look at how this asset can be better utilised as part of a retirement income strategy instead of simply being an inheritance for the children or grandchildren. The median house price in Sydney is about $1.1 million and in Melbourne $900,000.

Currently, there are five ways the family home can be used to generate income, and they all come with pros and cons. In the future I would expect there will be greater sophistication about how this asset can be used for an ageing population with limited superannuation and governments needing to rein in the deficit. But this is what’s on offer now, with some benefits and costs:

1. Downsizing

• Depending on the state of the property market and seller’s price ambitions, sale time can be relatively quick.
• Good option for those seeking a sea change, tree change or simply smaller accommodation.
• The cost of selling and relocating can be prohibitive, including agent’s fee, advertising, stamp duty on new property, any modifications and relocating expenses. The costs eat into the gain.
• The emotional stress of being unable to afford to relocate in the same area and having to move away from family, friends and familiar surroundings.
• The potential ability of the over-65s to put some proceeds into superannuation.

2. Reverse mortgage

• Equity release product allows access some of the capital in the house.
• Minimum age to participate is 60.
• Typically, mortgage limited to 15-20% of the equity, minimum loan $10,000.
• Choice of regular payments, lump sum or both.
• Better suited for those without dependents.
• A credit product so financial planners need an Australian Credit Licence (ACL) to offer advice.
• Only available in selected postcodes.
• Interest rates fluctuate and can move against borrower, with the consequence of reducing equity in the property, so the final outcome is unknown.
• Take-up of this product has declined, in part because people, having paid off their house, are reluctant to create another debt over it.
• Interest owing on the debt is capitalised, increasing the debt burden.

3. Government Pension Loans Scheme

• Government reverse mortgage offering regular income stream, can be short-term or indefinite period.
• No lump sum payments.
• Regular payments cannot exceed 150% of the pension payment.
• Loan can be repaid in full or part at any time.
• The full amount of the loan plus interest owed at the time of the death of the person will be recovered from the person’s estate.
• Current interest is 4.5% with eligibility requirements.

4. Wealth release

• Offered by Homesafe Solutions, a joint venture between the Szabo Group and Bendigo Bank.
• Launched 15 years ago to provide a debt-free equity release solution for older Australians.
• Unlike a reverse mortgage, Homesafe buys a share of the future sale value of a house. The homeowner retains the title deed.
• Homesafe calculates the payout based on (a) the future share of the house to be sold (b) homeowner’s age (c) house value today. The payout can range from $25,000 to $1 million.
• In return for a lump sum up front, Homesafe receives an agreed percentage of the future sale proceeds of the house. There is no time limit on any sale.
• Homeowners can buy back their share at any time.
• Homeowners can still rent out the property and retain the income.
• It is a real estate product. Financial planners cannot offer advice on it.

5. Fractional senior equity release

• Currently only offered by fractional investment manager DomaCom.
• Equity-based not debt.
• Accessed exclusively through licensed financial planners requiring seniors to obtain advice first.
• Investors get a fixed rental income and a share of the property’s capital gain at the time of sale.
• Investors can include family and friends and may be able to use their superannuation to invest.
• Base service fee is 4.4% p.a. fixed for life of the contract.
• Seniors have permanent right of abode.
• Some of the equity released is used to pay rent on the ‘fraction’ of the property released.
• If the homeowner chooses, they can rent the property out and keep the rent.
• Choice of lump sum or a regular payment.
• Maintenance, repairs and insurance are shared with investors.
• On selling, seniors and investors each get their percentage of the sale price.

In future, expect the government to demand the family home pay a greater role in financing retirement, with borrowers needing to assess the wide range of products available for their unique circumstances.

Arthur Naoumidis is CEO of DomaCom. This article is general information and does not consider the circumstances of any investor.