Just look at the latest equity release lending figures from the Equity Release Council. Over 11,000 new equity release plans were sold in Q2 2018. Plus, following changes in the rules introduced recently by the FCA we have seen more Retirement Interest Only (RIO) mortgages come to market, which can only increase the numbers who tap into their housing wealth. Add to that the numbers who downsize and housing wealth has become a mainstream source of retirement finance.
But, what does that mean in practice?
Saving for retirement
According to Royal London, someone who rents in retirement will need an additional £180k in their retirement fund to pay their rent during retirement. It is estimated that those on average earnings who save 8% into an auto-enrolment pension will have saved £56k by the time they retire.
Put simply they would have to save three times that amount just to pay their rent in retirement. If they did, what would they be left with to meet their housing costs?
This type of statistic clearly makes the case for home ownership as part of a retirement savings strategy. Home ownership and paying off the mortgage before retirement becomes just as important as saving into a pension.
Retirement income planning
If housing wealth is to be used to supplement retirement income, how much and when will it be drawn becomes an important retirement income-planning discussion.
Firstly, it is important not to get carried away with the amount that can be released from a home. Clients should remember they’ll still need somewhere to live. Therefore from a planning point of view I would recommend that before any detailed calculations are completed, there is an assumption that not more than 20% of the value of the house will be used for retirement income.
Coincidentally £56k – the average auto enrolment saver would have amassed in their pension – is also approximately 20% of the average house value.
If that amount is going to be realised through downsizing, the earlier in retirement it’s done the better the outcomes will be. In theory a smaller home should cost less to run and reduce the strain on pension savings to provide the required income.
Tax regimes should lead to the conclusion that once the downsized proceeds have been realised they should be drawn down in preference to the pension savings held. However, one must not overlook what allowances are available to transfer some of the downsized proceeds into tax-advantaged savings wrappers such as ISAs and pensions.
If there are specific plans to move closer to children or the coast at a specific time in retirement the position becomes more complicated. Will they draw on their pension savings to meet their income needs for a period, then use their downsizing proceeds until they have expired, then revert to their pension savings?
In this situation, you may have to identify a portion of the pension fund that may not be called upon to provide income for 10 years or more. This may affect decisions about how the pension savings should be invested. An example could be that you need to draw income for five years, no income for the next five years, and then use the balance pension savings to provide income for the rest of life.
Equity release scenarios
Usually those who use equity release will prefer to delay accessing their home equity until after they have utilised their pension savings. This is because they wish to mitigate the impacts of the compounding of rolled-up interest from reducing the equity in the home from reducing by too much any bequest they wish to leave their children. Products exist that restrict the roll-up of interest to protect a specified inheritance amount.
Those who use equity release to reduce potential inheritance tax bills may wish to use equity release earlier and bequest their pensions instead of their home. If, instead of equity release, the client prefers to use a RIO mortgage, they will need to identify that they can generate sufficient income to afford the interest.
What does this mean for advisers?
The use of housing wealth is becoming an important aspect of retirement income planning. Advisers need to become holistic financial planners. The retirement strategies they discuss with their clients need to take account of the housing wealth they possess and how they intend to use it.
Pensions and investment advisers therefore need an understanding of the mortgage and equity release markets. Mortgage advisers need to be aware of the various ways pension income can be drawn and developments in the equity release market. Equity release advisers also need to be aware of the ways pension income can be drawn and developments in the mortgage market.
Without such awareness how do you know you are devising the best possible plan for your client?
Bob Champion is chairman of the Later Life Academy (LLA)