New pension rules introduced on April 6 give people more options in their retirement but this won’t address the fact that many people have not saved enough for their golden years. One option is to release some of the money tied up in your property via an equity release mortgage. Andrea Rozario, chief corporate office at Bower Retirement Services, explains what those facing retirement should consider.
Pension freedom day has passed and the Earth still turns and the birds still chirp. The revolutionary changes that the Chancellor announced in last year’s budget were a shock to many and seen as a gamble by most. The annuity market no longer monopolises the retirement planning arena and people are being given the right to manage their retirement finances in their own way, via drawing as much or as little as they need from their defined contribution pension pot.
Now that we are several months into the post-pension freedom world, the immediate impact has been somewhat anti-climactic, but there may be serious delayed consequences approaching in the near-future. Regardless of the moral value of the pension freedoms decision, many retirees will find themselves in serious financial difficulty once they realise they haven’t saved enough for a retirement that will last longer than they may expect.
I am confident that most people will manage their finances intelligently – early figures appear to support this – but for those who have minimal pension pots to manage, the pension freedoms may create another minefield of confusion. For those retirees that have come to realise that they simply don’t have enough to fund their retirement, equity release could become a valuable lifeline.
The problem with longevity
Before looking at equity release, we first need to address the fundamental questions all pensioners who choose to draw from their pension pot will have to ask themselves:
The first question is how long will I live? And secondly, how much money do I need?
With the annuity market no longer having near-exclusive control over retirement financing, those who choose to draw down on their pension pot need to ask themselves these critical questions or risk seeing their pots run dry.
They say ‘responsibility is the price of freedom’, and many pensioners will discover that they must be responsible with their savings and budget themselves carefully.
For many people, the answers to these questions will be less than satisfying. At 65 years old, the average man will live another 18 years and the average woman another 21; however, these predictions remain just predictions and many pensioners will live well into their 90s and more centenarians than ever will receive a letter from the Queen.
Her Majesty may have to buy a few more biros or delegate the task to Charles (the prolific correspondent that he is). Good news, right?
Well, the longer you live the finer the budgeting balancing act becomes, and those who fail to balance their finances adequately will exhaust their pot within their lifetime. What’s more, in light of the stock market’s recent performance, pension pots can quite easily be depleted at a much swifter rate, regardless of the pension holder’s prudence.
The simple fact is, thousands of retirees will not have saved enough to provide for an ever-lengthening period of retirement. Our own research at Bower Retirement Services confirms this fear as the median private pension wealth held by people aged between 65 and 74 stands at £108,400, but collapses to £43,200 for the over-75s.
As retirees have now been given the right to organise their finances in their own way, many will come to realise that their finances will be stretched at the worst possible time: old age. The freedom to manage one’s own finances and plan with care is a principle we should all support, but for those who come to find that their pots aren’t full enough, alternative means will have to be considered.
The tax trap
Other than retirees simply not having enough saved for retirement, there may be a punitive sting in the tail for those wishing to draw from their pension pot. As was the case before pension freedom day (April 6), withdrawals from pension pots will be taxed as income beyond any withdrawal over 25 per cent of the total value.
However, basic rate taxpayers may find that they wander into the territory of the higher rate if they withdraw too much from their pot. For those that have paid basic rate their entire lives and saved admirably, this may feel a tad unjust. In a survey of 55-65 year olds conducted prior to April 6, 41 per cent strongly agreed that it was, ‘shocking that average earners would have to pay the higher tax rate’.
For those retirees who wish to draw from their pension pot to fund their retirement, navigating the tax traps will be a serious concern. Many retirees will realise that they have to bite the bullet of a higher tax bill in order to draw enough to maintain their lifestyle into retirement, and this decision will facilitate an even speedier exhaustion of their pension pot. At this point, the allure of tapping into housing wealth may be too much to pass up.
The housing wealth solution
Despite pension pots running dry for many people in later life, thousands of homeowners will have seen their home increase in value over the years.
According to cross-party think tank Demos, in England alone, over four in five over 60s own their own home. So, with house prices having grown by over 4,000 per cent in the past 40 years and the over 60s now controlling over £1 trillion in housing wealth, this swelling equity pool could provide the added income many will need come retirement.
To put this house price inflation into context, if this increase was applied to your weekly shop, a chicken would cost £51.18, four pints of milk would cost more than a tenner and a fiver would only just buy you a loaf of sliced white bread.
Average house prices have indeed increased at a great rate over the past four decades, but the gains felt by homeowners are trapped within their property; the equity needs to be released to provide the homeowner with the funds they may need. Downsizing is one way of releasing this equity, but this can often be a costly process, both financially and emotionally. Downsizing will be cheaper in the long-run when compared with equity release, but many people simply do not want to downsize and wish to stay in the home they have come to love.
Equity release can convert historic house price gains into tangible, tax-free cash whilst ensuring that you can stay in your home for life. The lifetime mortgage, the most popular equity release product, can provide the funds many will need in their later life, but regulated advice is essential and you should only ever use products endorsed by the industry’s trade body – the Equity Release Council.
It is important to note that equity release may not be suitable for everyone, and all options should be considered. Downsizing could still be the best option as equity release will reduce the value of your estate and could have an impact on your entitlement to state benefits. But weighing up the benefits and drawbacks of equity release is something many retirees will have to consider as their pension pots dwindle and they live on into old age.
Time will tell
We have entered a new and exciting phase of retirement planning, Chancellor George Osborne has stated that: “It’s right you have this new pension freedom – after all, it is your money,” and here at Bower we share his sentiment.
The problem is that despite it being ‘right’ in principle, in practice many retirees have not saved enough, will live much longer than they expect, may fall foul of the tax traps and will therefore need the option to access products like the lifetime mortgage to sustain the retirement they desire.
The pension freedoms will, I believe, be utilised by people over the age of 55 in a responsible fashion, but many will come to realise that they have miscalculated their retirement savings and will therefore need to find another source of income.
Equity release will continue to become an ever more popular form of financing in retirement as homeowners turn to their most profitable and wisest investment: their home.
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Scenario – solution to an interest-only mortgage shortfall
Mr and Mrs Cliffe, both aged 65, had always hoped to enter retirement with their mortgage paid off and their
finances in a healthy state. Unfortunately, like many retiring couples, they had a large shortfall on their interest-only mortgage and it was more than they could afford.
With a £40,000 shortfall hanging over them, threatening to tarnish their retirement, they began to consider equity
release. They wanted to remain in the local area so downsizing was not an appealing option.
The Cliffe’s combined personal pension pots would not stretch far enough to clear the shortfall and fund a reasonable retirement, but their home had increased in value over the years.
Having purchased their home for little over £60,000 in 1994, the property had now increased to around £170,000 – nearly a three-fold increase. The new pension freedoms had allowed them to take small withdrawals from their personal pensions, but this would not fund the 20 years or more they hoped to have in retirement.
By releasing £50,000 from their housing wealth via a lifetime mortgage, Mr and Mrs Cliffe were able to clear their interest-only shortfall and retain £10,000 as a drawdown facility for any future eventuality. What’s more, any future house price inflation would preserve the equity in the Cliffe’s home and they were guaranteed the right to live in their property for life whilst supporting themselves financially.
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