Retirees are being encouraged to spend their savings, even “eating the house”
One of the more intriguing measures in this year’s federal budget was the extension of the Pension Loans Scheme to all pensioners.
The scheme currently allows a part-pensioner or self-funded retiree to borrow money from the government against the value of their house or other real estate assets.
The original idea of the scheme was to allow people who are asset rich but cash poor to be able to gain some cash flow. It is a government assistance package that competes (in some ways) with private operators that offer reverse mortgage schemes or equity release arrangements.
I’ll be straight upfront here. I have never liked reverse mortgages, not since the 1990s when the Victorian government explored ways to create them with several friendly societies but withdrew because the risks were too great (mainly to the consumer).
Like any financial instrument, the payback for government in the short-term is minimal but the compounding of interest eventually sees swathes of equity change hands.
The federal government has run its own version of a reverse mortgage for some time.
After the budget, the treasurer, Scott Morrison, told me he felt it was only fair that a scheme which is available for people with larger amounts of assets or real estate should also be available to those who claim a full pension.
Currently, the scheme’s eligibility criteria are straightforward:
– You or your partner must be of pension age.
– You must own Australian real estate to use as security for the loan.
– You or your partner must either receive a payment that is less than the maximum or none (this is the part being changed by the budget).
– You must meet pension residence rules.
The loans scheme is also available to people who receive less than the maximum of bereavement allowances, carer payments, disability support pensions, widow B pension and wife pension.
Now comes the detail: the interest rate on these loans is currently 5.25%, which is higher than what banks might lend at.
Remember, though, that unless you have a reliable source of income, banks will be reluctant to lend to you (this goes to what the royal commission has heard about inappropriate loans made to people who had no chance of paying them back). There are also legal costs associated with setting up these loans.
A single homeowner can claim the full age pension if their other assets (including super) are less than $235,730; for married homeowners it’s $380,500.
For people who own their own home, and with assets below these levels, the single person pension payment is $826.20 a fortnight (the pension supplement and clean energy supplement top this up to $907 a fortnight, or $23,582 a year) and for couples it’s $622.80 a person per fortnight, topped up with supplements to $684.10 ($35,575 a year).
The Pension Loans Scheme currently allows a person to borrow annually a maximum of 100% of the age pension (if they receive no pension) and, for part pensioners, a sum that would top up their existing pension to the age pension mark.
But this is where the budget extends the scheme. If the legislation is passed, the extended scheme will come into effect from July 1, 2019.
It will increase that annual borrowing limit to 150% of the age pension, meaning a married couple not receiving any pension can borrow a maximum $622.80 x 2 x 26 x 1.5 = $48,578 a year.
With the budget rule changes, a person on the full age pension will be able to top up their pension each year by a maximum $11,791 for individuals and $17,787 for couples (and this will increase with general pension rises). It means a single full pensioner, borrowing from the equity in
their home, will see their “income” rise to $33,000 a year (most of it tax free).
But you have to work out whether this scheme is worth it.
Using simple maths, if you have a $1 million house today, with the interest rate at 5.25%, and assuming no capital growth from your property, you will have no equity left in your house after 20 years. In effect, you will have eaten your house.
But the scheme is broadly based on an assumption that house prices will keep rising over time (heaven help us all if prices ever generally go backwards by 20% or 30%).
When I use an annual average growth rate for the house of 4%, it changes the maths. In effect you can be in the house for decades before the equity runs out but, again, this presumes no calamitous fall in general house prices, nor any big increases in the amount the government will let you take out in the future.
Low interest rates and returns have already upset many retirees’ plans. Now the message from the government is clear: consume more of your assets (including your house) in your retirement years and leave less for the kids.