Nigel Hare-Scott discusses how the equity release design has evolved to make it an important part of any retirement planning strategy
Inflation is falling and deflation may soon be with us. Irrespective, homeowners in retirement will be feeling the pinch as the utility bills land on the doormat. Indeed, the cost of living for the elderly is markedly higher than the published indices and increases in the state pension will be very modest if based on the projected Retail Price Index (RPI).
For prudent investors who have put aside some of their hard earned income, there will be scant reward, as retirement savings will be earning only a pittance with interest rates diving toward zero. Annuities have for many years been perceived as offering poor value. Indeed, those approaching retirement need a large capital sum so they can maintain a reasonable lifestyle after they cease working. That sum needs to be significantly bigger if index linking and/or a spouse's pension is to be covered, even more so if you have led a healthy life as a non-smoker.
The purchase of a life annuity may provide some certainty for income after it has been acquired. However, the decision-making process is fraught with challenges, more so after the recent sharp falls in investment markets. Clients will be asking themselves:
- Will I get more by delaying?;
- If I do wait, will it make me worse off?;
- Will I come to regret my decision later?;
- Do I want to pass my pension pot to my estate?;
- Will the law change by the time I am 75, when at present I am effectively forced into buying an annuity irrespective of the value of my investments at the time?
Financial intermediaries are thrown into the middle of this. Regrettably, being obliged to make clients aware of the alternatives and the risks is not always perceived as being helpful and they might prefer to remain blissfully ignorant of them.
Rigorous decision making
It is largely because of the tortuous decision making process that income drawdown has become so popular. Drawdown enables those in retirement to supplement their retirement income without completely losing their pension portfolio. In other words, they can delay making a decision. However, drawdown does of course potentially reduce the size of the future cake - robbing the future to pay for today.
There is, however, another way. An equity release transaction has similar characteristics to an annuity purchase. It is a decision made late in life, it is normally designed to last forever and it is often deemed as a last resort course of action. There are even those who would argue that resorting to equity release is a recognition that you have managed your financial affairs imprudently. This is clearly ridiculous after a year when the disadvantages of having a large percentage of your wealth tied up in the home has become only too clear.
Drawdown enables the client to defer the purchase of an annuity and receive tax-free cash while keeping their pension scheme assets fully invested. Similarly, equity release enables homeowners to release tax-free cash while retaining full or part ownership of their home.
Although equity release is often defined as a method of 'raising money from your home,' this definition understates the contribution, which it can make towards meeting retirement needs in the current financial environment. A fuller and more comprehensive description might define it as a method of 'raising capital or income from your home without having to pay rent or interest during your lifetime'. With the value of homeowner equity exceeding £1 trillion, even after recent falls in house prices, the scope for equity release as a mechanism for improving retirement lifestyles is all too apparent. It is a real alternative to income drawdown and a serious option for those who need to defer annuity purchase until stock markets have recovered.
Retirement planners will be relieved that to date, a full range of equity release products is still available to their clients at attractive interest and loan to value rates. The difficulties in financial markets are, however, changing the shape of the sector in that the annuity-funded providers have moved into the ascendancy. It is estimated that such providers now account for over 70% of the equity release market.
The symmetry between annuities and equity release is particularly striking in that the prospective return to the provider is related to the life expectancy of clients in or approaching retirement. Moreover, receipts from the sale of annuities can generate the finance for equity release plans with lifetime mortgages offering a secure asset and long-term income potential for providers with no affordability issues.
Now that the annuity providers in the retirement market are taking advantage from the similarities of the two product types, consumers are also able to benefit from the linkages between them when planning for retirement. For example, via regulated equity release transactions, homeowners can:
- Release tax-free cash by lifetime mortgage or home reversion plan to top up their pension pots
- Obtain tax relief at the marginal rate on their pension fund contributions
- Maximise the 25% tax-free cash withdrawal from their pension pots
Given the above advantages, it is remarkable that it has not already become more commonplace for advisers to present equity release options to homeowners when they are planning the choices available to clients in retirement.
With an increasing age profile of the population underpinning the demand for annuities and equity release, it is reassuring that the growth of both product types can complement each other at a time of funding constraint elsewhere in the economy.
A house is more than a home. It is where the heart is and the future pension. Releasing tax-free cash from the equity in the home will soon become the normal rather than the exceptional course of action for homeowners, seeking to boost their retirement incomes.
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