Converting Assets to Income
Introduction - Political Leadership needed
As we make clear elsewhere on the site, we do not believe that the current Australian retirement/pension arrangements are financially sustainable. As the population ages there will be fewer taxpayers to support a rapidly increasing pensioner base, and whilst superannuation savings will materially improve the situation in the future, it will have little material impact in the short to medium term.
Currently, the main residence of age pension applicants is not included within the pension assets test, but we remain of the view that this will almost certainly need to change at some point in the future. Present Australian politicians fear the electoral backlash associated with changes in this area and therefore we have previously indicated that changes will only likely result from a "funding crisis" - something which the current corona virus pandemic will likely deliver.
It remains an economic nonsense to fully exclude main residences from the assets test. There is a growing community awareness that some age pensioners occupy properties worth many millions of dollars, and there will probably be further angst when the community realises that the property they occupy will often pass to beneficiaries with no (CGT) tax being paid. What makes this more galling is that many of these people do not live expansive lives - the pension is barely adequate to sustain properties of this value - and yet through mechanisms such as the pension loan scheme or reverse mortgages there now exists more of an opportunity for them to draw a reasonable income from their asset base.
In any event, it will almost certainly become politically and economically unaffordable for the government to support pensioners who are "asset rich and cash poor". There needs to be more focus placed on how retirees can equitably and efficiently convert their (illiquid) assets into an income stream to support them through retirement and/or cost effectively move into smaller, purpose built accommodation.
Simultaneously, something should be done to address the moral hazard implicit in Australia's pension arrangements, where it seems that individuals who do not plan and save for their retirement can appear to be disproportionately rewarded for that behaviour. In other words,
"What is the point of saving and scrimping for 30 years if the end result is that I receive a part pension, and about the same income as my neighbour who chose to spend rather than save and is now on a full pension."
Government policies need to encourage saving by ensuring that individuals receive a commensurate return, and do not effectively reward contrary behaviour. Easier said than done, and that includes limiting the ability of individuals to alienate assets in order to qualify for the pension; but the cost of not getting the balance right is extraordinarily high.
Converting Assets to Income - Some Options
These are some of the ways in which illiquid assets, such as homes and property, can provide income.
Pension Loan Scheme
As we suggested some time ago, the Government has now, since July 2019, extended the Pension Loan Scheme to better allow individuals to more flexibly use the equity in their properties to finance an income stream. The interest rate applicable is now a much more competitive 4.5% and a better marketing of this ould see this having a major impact on the quality of life of many retirees.
Whilst the downside is that the PLS scheme generates debt, unlike the student loan plan it would at least be secured against property and replace government expenditure.
As we discuss elsewhere on the site, reverse mortgages are an existing option which allows individuals and couples to convert their home equity into an income stream. They largely suffer from a poor public profile because of inappropriate selling a number of years ago, but a number of products changes now make them suitable mechanisms in many situations - for example, government legislation now makes it impossible for borrowers to owe more than the value of their property and end up with "negative equity".
The importance of the family home is reflected in a survey carried out by Roy Morgan in 2016 which showed that the average net retirement savings per person for those intending to retire in the next 12 months was only $281K. A great majority (83%) of these people either owned or are paying off their home, with an average value of $495K per person or 151% higher than the average held in superannuation.
One of the other issues with reverse mortgages is a preference by many pensioners and their immediate family to leave the family home as an inheritance. That is an understandable preference, but it should not be at the expense and security of retirees. As we mention above, there is also a limit to which society can afford to support individuals who are "asset rich and cash poor" - individuals receiving the full age pension but sometimes living in property worth $1M or $2M. Address this question or the Treasurer's vow to never include the main residence in the assets test may lead to other "evils" - such as pressure for the (re)introduction of inheritance taxes.
The practical problem with reverse mortgages at the present time is, as is also the case with annuities, that they are relatively expensive. Given the (unduly) large amounts of money tied up in real estate in Australia, and an ageing population, it seems obvious that reverse mortgages should play a much greater role in providing retirement income. That could change if a significant increase in the market also resulted in lower margins, interest rates and administrative charges or changes in the assets test - plus suitable regulation to ensure that over lending was not possible.
Selling part of your equity in your Home ("Home Reversion")
Another option offering access to some of the value in your home is to sell part of your home in what is called a "shared equity product". There is only one product in the market at the moment, Homesafe's "Wealth Release" (which is a joint venture of Bendigo and Adelaide banks) and it is limited to certain postcode areas in Melbourne and Sydney, and a number of other eligibility restrictions apply.
Under this approach, you sell a proportion of your home at a discount and Homesafe keeps the upside in the value of its share in the property when it is ultimately sold. Importantly, there is no accumulating interest bill and a certain percentage of the property remains available to either bequeath or have available should you need to move into a nursing home.
Both prior legal and financial planning advice are very much recommend - particularly to determine whether the lump sum payment you are receiving is fair and reasonable in the circumstances.
Move to a Smaller Property
It seems obvious that one way individuals living in family homes could access income, would be to move to smaller retirement homes, liberating some of their equity which could be used to generate income. In practice there exist several hurdles.
Firstly, smaller retirement homes and "empty nester" properties are often relatively expensive, with the result that little or no equity is released. There is relatively little transparency in the retirement home market in Australia, and it is characterised by high legal complexity and, often, high profits. Buyers often face both high entry prices and deferred exit fees equivalent to between 35% and 50% of the initial purchase price. What is absolutely necessary is that all operators are required to make publicly available all their terms and legal documentation for comparative purposes.
Secondly, individuals are concerned that the equity liberated by the sale will count for the age pension assets test - this is a direct result of the main residence currently not being included in the assets test - see above.