Reading time: 14 minutes
On this page
- The three pillars
- One home many functions
- Asset rich, income poor
- Super gap is closing too slowly for some
- No such thing as a standard retirement
- Unlocking housing wealth
- Tighter regulation of reverse mortgages
- Growing awareness of equity release
- Strategies for home equity release
- Missing links in retirement income system
- The bottom line
Retirement planning often begins and ends with a discussion about how much super you have and whether it’s enough. While super is important, it’s not the only source of income and support in retirement.
If you’re reading this at home, the missing piece of your retirement income conundrum could be closer than you think. You’re sitting in it.
The three pillars
Australia’s retirement system is underpinned by three potential sources of income, or three pillars:
- A means-tested Age Pension,
- Compulsory superannuation, and
- Voluntary savings.
However, the terms of reference for the government’s Retirement Income Review explicitly include home ownership as part of the third pillar. That is, the government is signaling that the family home should be regarded as a form of savings.
This may come as a surprise to Aussies who regard their home as their castle. It also begs the question: How and when can these savings be withdrawn?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.
Speaking recently at the Household Capital Third Pillar Forum, Professor Hazel Bateman of the UNSW ARC Centre for Population Aging and Research said Australian homeowners aged between 60 and 80 have 10.5% of their assets in super, 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 are currently less than $250,000. While that percentage is set to drop to 35% over the next 20 years, 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.
While the percentage in the middle, with $250,000 to $750,000 will double from around 25% now to 50% over the next two decades.
For this middle group, retirement planning is complex according to Andrew Boal, chief executive of Rice Warner Actuaries. Also speaking at the Third Pillars Forum, he said 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, he says 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 needed 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 or cleaning.
No such thing as a standard retirement
Using the ASFA Retirement Standard as a guide, Prof. Bateman says 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 $62,000 for couples and $44,000 for singles. That’s significantly higher than the Age Pension which is currently set at around $37,000 for couples and $25,000 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?
Prof. Bateman says studies have shown that most people use a form of mental accounting which 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?
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 (currently 66 and over) 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. Unlike commercial reverse mortgages, you can only access your home equity as an income stream, not a lump sum. However, the current interest rate of 4.5% is lower than commercial rates although the gap is closing.
Australia has a high rate of home ownership, but many people still don’t have enough money in their Age Pension or superannuation for a comfortable retirement. To talk about the growing conversation around accessing equity in your home, we’re joined by Dr Sarah Sinclair from RMIT an applied economist with an interest in wellbeing and ageing, who’s co-authored a report on this topic. Hi, Sarah.
Dr Sarah Sinclair
Hi, Tracey. How are you? Thanks for having me to talk about this important topic today.
My pleasure. In simple terms, what is equity release?
Dr Sarah Sinclair
So as you mentioned, about 80% of Australians have home ownership and within the value of that home there are means that you can access that value. And when we talk about equity release, we’re talking about what kind of mechanisms are in place where you can access the value while still remaining in your home, retaining ownership of that home and being able to enjoy some of the benefits that that asset can give you to support retirement incomes.
So there are a number of different mechanisms through which we do that. And I guess we’re most familiar with the downsizing component of accessing equity where we say ‘let’s sell the house and we’ll move into something smaller’. And in that way, you’ve sort of released that equity in that process.
But there are a number of financial products out there that can facilitate you to remain in whichever house you’re in, which often is the family home that you’ve been in for a long period. You’ve raised a family. You’re comfortable in that environment and comfortable in that community. And these equity release products can enable you to access some of the value of your home while staying in your home.
So reverse mortgages would be one. There are also a home reversion products, and there are new products coming to market at the moment, such as that by Domacom, which is a senior equity release product. So there’s a number of products that are out there in the market that facilitate your access to that equity.
Based upon your research for this report, is there enough information available for Australians about all of these options, including things like the Pension Loans Scheme?
Dr Sarah Sinclair
Yes. So as you mentioned, the Pension Loans Scheme is one of those alternatives that can be accessed to gain access to your equity in your home. In terms of information, it is complex and it’s very much linked to your own personal situation. So the type of product that you want to access in the market is going to very much depend on your own personal needs and wants. I must say that there is definitely a gap, an education gap. We know that older people are very competent and confident in managing their money. And is this is well known. But they’re not very comfortable with taking on debt and understanding those products.
ASIC recently identified, that these products can be really important in raising standards of living. But there’s very much an education gap and that they’re not well understood in the community. So I think there’s definitely room for improvement with access and education around these kind of financial products to see what’s available.
The financial loan scheme has been quite almost difficult to find out about. I mean, there hasn’t been much promotion of it. In recent months that has changed. And obviously with the recent report from Treasury, where there’s been a little more in-depth modelling of the kind of benefits these products can bring, there’s been a little more traction around these products, a little bit more information getting in through media sources.
The MoneySmart website is a really good place to start. I think there is some good information there, but you have to seek it out. And I think that’s important. We want more financial planners who are engaging with people, making decisions around retirement or just some more general discussions around the existence of these types of models or products – that they’re out there, that they do provide value for people depending on the circumstances.
They have in the past been linked with some negative connotations. And I think that’s kind of being dealt with in a regulatory sense over the years and not so much even within the Australian context. But I think there needs to be a little bit more work around that in terms of dealing with, just educating, getting more information out there.
For those who do access their home equity, what kind of things are they spending the money on?
Dr Sarah Sinclair
That’s really interesting. So what we have seen and this relates to our recent report. What we’ve identified, we’re looking at over 15,000 different loans and what people have reported they have used those loans for, is that there has been a shift in recent years to using equity in their home to pay down debt so that people are entering with debt, and particularly mortgage debt as they enter retirement.
And that is indicative of the housing market more broadly and changes that we observed in recent years where people are later getting into the housing market, housing affordability issues that I think have been a major concern in recent years, and then disruptions over the life course. If there’s a relationship breakdown or divorce, I mean, that can always mean that there’s a re-establishment of a different household. And trying to get into the housing market again means that you’re more likely to be carrying debt through to closer to retirement.
So there’s a lot of kind of structural changes that mean that that debt is being carried through to retirement, which once you hit retirement and you’re and there’s a change in your income, obviously relaying that debt or paying down that debt has become more significant as a usage.
The other primary resource sorry, I was just going to go with the next use, which is home improvements, and this is something I’m kind of passionate about because I think we all need to be thinking about the type of housing that we want to live in as we age. Just from my personal perspective, I bought a house recently, and I wanted to make sure that I had a bedroom on the ground floor and a bathroom on the ground floor.
And a lot of this has to do with what I observed my parents go through when they became less capacitated as they age. So I think home improvement is often another category that people drawdown and spend that money on. It used to be the primary and now it’s reverted to a secondary after relaying the debt. So it’s not necessarily a big spend up on a holiday that people are using it for, but it is you know, it can serve as a very useful way to consolidate your debt and to move forward and manage your income.
The changes over the years are absolutely fascinating. Before I let you go, Sarah, just briefly, what kinds of problems are there with differences in regulation between the states when it comes to accessing home equity?
Dr Sarah Sinclair
OK, that’s an interesting one, because I think a lot of it comes down to the complexity in the policy between the different states. So, as I said, you’re dealing with different housing markets for a start, but you also have different regulatory or concessionary environments, for example, with stamp duty. So if you look at the variation in stamp duty between the ACT and Victoria, for example, I mean, for a $500,000 home you’re looking at $13,000 in ACT relative to $25,000 in Victoria. But then you’ve got all of these added complexities where there’s concessions in Victoria that there aren’t elsewhere.
So, you know, it becomes very difficult to compare like with like across the different states. And then we’ve got the broader federal policies coming in on top of that, which it adds to the complexity and again, links back to that education component that understanding the concessionary environment and understanding the engagement with the pension and the eligibility criteria for the pension, that there are things that that we need to make clear or to be able to understand.
And we do need to do that at a state level because because of the different policy settings. So that can just adds another layer of complexity that we need to deal with.
Dr Sarah Sinclair, thank you so much for breaking down this complex area for us all.
Dr Sarah Sinclair
Thank you. It was lovely to talk to you. Tracey.
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. While there are still risks, the regulation of these products is much improved, according to ex-ASIC deputy chair, Peter Kell.
Kell says 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 Financial Complaints Authority which can hear consumers’ complaints for free.
Growing awareness of equity release
Although the PLS has been operating for 35 years, the take-up was low because few people knew about it. But an extension of the eligibility criteria in July 2019 resulted in a jump in participants to 3,100 in the 2019-20 financial year compared with less than 800 the previous year.
According to Pension Boost, a company set up to guide people through the PLS application process, the median house value of people using their service is $525,000 (ranging from $130,000 to $5 million). Regional and rural customers account for 55% of applications and 48% of applicants still have mortgages.
Josh Funder, chief executive of reverse mortgage provider Household Capital, agrees that demand and awareness has increased recently due to a convergence of factors.
“COVID and the pandemic-related recession has hit retirees hard. Super balances are volatile with a lower growth outlook, term deposits are effectively zero, dividends are much reduced and rental income is low and volatile,” he says.
All of 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
Funder 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.
Based on the traditional rule of thumb that says a 4% drawdown of your available investments should be enough to fund 30 years of retirement, Funder would like to see people adopting a 3+1 strategy. That is, a 3% drawdown from your super plus a 1% drawdown from your home equity.
He says actuarial modelling shows a modest drawdown of 1% of your home equity each year in retirement should be enough to provide a sustainable and adequate retirement income. By age 90, most people should still own more than 50% of the value of their home.
Prof. 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.
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.
Prof. 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 67 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.
Fortunately, it is believed the Morrison Government is open to ideas that would better integrate the family home into the broader retirement income system. As always though, the devil is in the detail.
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 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 home equity, it needs to be viewed as part of your overall retirement income plan. You should also consider seeking independent financial advice.