What you aren’t told
Many of the authoritative statements relied on by Retirees focus on retirement income alone, rather than on the wider context of all retirement assets.
For example, an often quoted guide is the amount of “income needed for a comfortable retirement“.
The Association of Superannuation Funds of Australia (ASFA) defines “comfortable” as “being able to pursue a range of leisure and recreational activities, as well as afford private health insurance and occasional international holidays” and quotes an amount needed of 67% of pre-retirement income in its Retirement Standard.
The ASFA guidelines are not incorrect, indeed it is one measure used in our own Annuity Income & Mortgage Calculator.
The income calculations by ASFA are expressly based on the assumption that the Retiree owns their family home, without a mortgage.
However, the significance of this key assumption is commonly overlooked or its implications not fully understood.
It is simply not enough to focus solely on retirement income alone, since this will not pay for a Retirees aged care accommodation bond ( RAD). In most cases, that will be funded from sale of the family home when a Retiree is no longer able to age in-home.
The reality is that a retirement funding gap will emerge where a Retiree has depleted most or all of their home equity through use of traditional equity release products (i.e. reverse mortgages, shared appreciation mortgages, shared equity mortgages, retirement interest-only mortgages). Rarely is this warning given to Retirees by industry professionals or financial advisers.
In circumstances where a Retiree is left without sufficient equity to fund the aged care accommodation bond (and remember there may be two RADs – one for each partner if they separately enter aged care at different times – perhaps as a result of one experiencing a medical episode before the other or where they have different levels of care needs requiring separate rooms – then they have few alternatives:
- join a long waiting list for one of the few government-subsidized places that a facility is required to offer
- share a low-cost room designed for 2 up to 4 occupants
- pay much higher daily accommodation payment comprising a daily rental fee plus interest penalty (DAP)
The ASFA calculations of income needed for a comfortable retirement simply do not account for these common circumstances and extra accommodation costs.
Further, the ASFA retirement income calculator does not include any amount for daily care costs in aged care.
A Retiree who has no home equity from which to pay an accommodation bond may need between $56,000 up to $65,000 per annum in retirement income that has not been included in the ASFA calculation, in order to pay for:
- fixed basic fee of $51.21 per day
- means-tested care charges of up to $75.43 per day
- daily accommodation payment typically between $81.64 (for a room having a $500,000 accommodation bond equivalent) up to $106.14 per day (for a room having a $650,000 accommodation bond equivalent), less the maximum government subsidy of $55 per day
Retirees no longer active or ageing-in-the home, need to refer to the current Schedule of Fees and Charges for Aged Care in the Australian test market.
Measures of income needed for a comfortable retirement must be better understood and considered in a wider context of real-life ageing issues if Retirees don’t wish to be caught in a retirement funding trap.
Futureproof is able to rely on the ASFA retirement income calculations only because our Equity Preservation Mortgage™ equity release mortgage preserves all home equity so it is always available for these future funding needs, if and when required. This is not the case with existing equity release mortgage products, such as reverse mortgages and Retirees need to consider not one, but two, funding variables in their retirement funding equation being income + home equity.
Retirees also need to look other traps in traditional retirement income products and existing equity release products.
The pros of these products seem obvious, but there are plenty of cons – whether they are annuities or reverse mortgages.
There are, of course, product limitations common to all retirement funding products (including Futureproof products), which cannot be designed out or simply add too much cost to the product. These include:
- fixed term contracts
- income not inflation adjusted
- early termination costs
- funds invested conservatively will always deliver low returns
- institutional or counter-party risk can never be removed
- there is no such thing as a ‘no risk‘ product
Annuities require substantial upfront cash capital to purchase. This is always going to be a problem for the majority of Retirees, who are asset-rich and cash-poor.
What a Retiree is really doing when purchasing an annuity, is outsourcing their wealth management in retirement, to an insurer – this comes at significant cost. You are entering into a contract whereby the insurer takes your capital and, in return, pays a regular annuity income for an agreed period.
Retirees often overlook other retirement funding options, such as guaranteed income products and managed mutual funds or the option of self-managed investments in bonds & fixed interest asset classes, index funds, LICs and ETFs, all being relatively low risk but far less expensive than annuities.
Notwithstanding, many Retirees (even those who actually have sufficient money for retirement funding) will often buy an annuity solely driven by two fears:
- uncertainty created by longevity
- uncertainty of income due to investment risk & market volatility
However, there are widely recognized issues with annuities that need to be more fully understood by Retirees:
- the better your health, the poorer the value
- whilst your circumstances change, your invested capital remains locked up
- if early surrender is allowed at all, then it is very expensive with little or no return of premium
- poor investment returns
- fixed low withdrawal rate
Insurance bonds are alternatives to annuities that offer similar levels of protection with lower costs and greater flexibility.
It is worth noting that not all annuities are created equal:
- some now have different options and levels of protections (each comes at a cost)
- some are now market-linked (and will be taxable)
- a few have limited principal protection
Nevertheless, annuities will always be very expensive due to:
- anti-selection of risk by Customers, driving up the costs for the Product Issuer
- cost of guarantees
- insurer profit
- high costs of sale and commissions
There’s wisdom in an old insurance industry saying … “annuities are sold, not bought“…
Traditional equity release mortgage products
Retirees need to look for different traps in traditional equity release products, notably reverse mortgages.
Again, the pros are obvious, but there are plenty of cons:
- high risk
- high interest rate (upto 250 bps higher than a forward mortgage)
- compounding interest (not simple interest)
- amount released is entirely inadequate to fund retirement
- typical minimum borrower age 70 years old
- actual age determines the allowable LVR
- these LVR restrictions limit loan amount
- debt doubles around every 9 -10 years
- rapid depletion of home equity
- rate of equity depletion by loan interest increases over time
- rate of equity depletion increases even further if interest rates go up or property prices move down during loan term
Whilst financial regulators now require lenders to offer a no negative equity guarantee, the insidious effects of compounding interest charges and resulting equity depletion, leaves most Retirees with insufficient home equity to fully fund their aged care accommodation bonds.
To sell a financial product to Retirees without this hidden and self-insured risk is, in our view, irresponsible and unethical.
The risk of Retirees being left with no retirement funding options at their most vulnerable stage of life when, being unable to remain in the home when they can no longer age-in-the-home and low care becomes necessary or, worse, where high care is required following a medical episode, is both very real and unacceptable.
Given that an accommodation bond for a room in a quality aged care facility nationally is an average of $650,000 and in capital cities up to $1.3M, a Retiree should aim to preserve a minimum of $1 million in home equity for their future aged care needs.
Futureproof believes Retirees should always preserve their home wealth and that reverse mortgages should never form a part of any responsible retirement plan.
Better outcomes for Retirees
Futureproof products are built on our proprietary Equity Preservation Mortgage™ and work very differently to deliver far better financial outcomes by overcoming the inherent defects in traditional retirement funding products.
Futureproof products have the following unique features:
- all existing home equity is preserved and guaranteed
- all future home equity (i.e. capital appreciation during the loan term) remains the Borrower’s
- simple interest (not compounding interest)
- interest is paid as incurred
- no age limited LVR restrictions
- maximum 80% LVR borrowing
- lump sum option
- choice of annuity income terms
- choice of interest-only or principal + interest mortgage
- ‘choice of fixed loan terms from 15 to 30 years
- option to choose a lifetime mortgage with no fixed term
- reversionary rights to spouse or partner
- tax free
- lower interest rate
- fully insured loan
The average annuity amount released for a typical Retiree using an Equity Preservation Mortgage™ is $540,000 (interest-only mortgage) or $270,000 (principal + interest mortgage with nothing to repay), compared with just $80,000-$100,000 for a reverse mortgage.
How our retirement income products work
For Retirees, we recommend using our interest-only version of the Equity Preservation Mortgage™ so as to maximize annuity income.
Alternatively, a principal + interest version delivers a lower annuity income, but ensures there is nothing to repay at the end of the loan term.
The Equity Preservation Mortgage™ does not release the loan funds directly to the Borrower, but to the Lender who manages those funds for the loan term.
This is the first fundamental difference from reverse mortgages and more akin to how annuities operate.
Because loan interest is paid monthly on behalf of the Borrower and not simply deferred to the end of the loan, this results in simple interest and not compounding interest.
This, of course, is a second fundamental difference from reverse mortgages.
This unique design feature ensures that our Equity Preservation Mortgage™:
- is always going to be cheaper than a reverse mortgage
- has no negative equity risk
- has no age restrictions
- removes LVR limitations
- does not deplete home equity
Another way of looking at Futureproof’s unique product design approach is that the Retiree has, effectively, purchased a fixed annuity, not with cash, but with their home capital.
However, it gets even better than that.
At the end of the loan period, the Retiree, having received the annuity portion as monthly annuity income during the nominated income period, also now has the reinvestment portion of the loan principal returned in full at the end of the loan term.
It’s as if the Borrower has allowed the bank temporary use of a portion of their home capital for the period of the loan term, in order to make it work to fund the retirement and the bank then gives the capital back.
The Equity Preservation Mortgage™ is a variable-rate loan.
Every Equity Preservation Mortgage™ has the full protection of Borrowers Mortgage Insurance (BMI) to remove interest rate risk, capital risk and investment risk for the Borrower.
Futrureproof believes that Retirees are quite prepared to allow the Lender to use and monetize part of the stagnant, non-productive capital that is tied up in their home in this way provided:
- all capital is returned to them by the end of the loan period
- they secure certainty of retirement income needed for a comfortable retirement
- they are not exposed to interest rate risk, capital risk or investment risk
- all their existing home equity is preserved and guaranteed
- all capital gain on the home during the loan term remains theirs
- they are dealing with a Lender that is a regulated financial institution, bank or insurer
Futureproof Retirement uses the Equity Preservation Mortgage™ to fund fixed term annuity income for Retirees of any age.
We achieve this through:
- tax-free income stream for the annuity period selected
- payment of all loan interest on behalf of the Borrower
- mortgage insurance is funded on behalf of the Borrower
- existing home equity is preserved and guaranteed
- capital appreciation on the property remains the Borrower’s
A typical Retiree who has a home valued at the average for seniors of $1.1M (retirees average home value is 42% above capital cities median house price) can obtain $36,000 per annum in tax-free income for 15 years with no depletion of their existing home equity.