What you aren’t told
Many of the authorative 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”.
The AFSA guidelines are not incorrect, indeed it is a measure used in our own Annuity Income & Mortgage Calculator.
The income calculations by AFSA 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 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 (the 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. Rarely is this warning given to Retirees by industry professionals.
In circumstances where a Retiree is left without sufficient equity to fund the aged care accommodation bond (and remember there may be RADs – one for each partner if they separately enter aged care at different times 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-subsidised places that a facility is required to offer
- share a low-cost room designed for 2 or 4 occupants
- pay much higher daily accommodation payment comprising a daily rental plus interest penalty (the DAP)
The AFSA calculations of income needed for a comfortable retirement simply do not account for these circumstances and accommodation costs.
Further, the AFSA retirement income calculator does not include any amount for daily aged care costs.
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 AFSA 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
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 this retirement funding trap.
Futureproof is able to rely on the AFSA retirement income calculations only because our Equity Preservation Mortgage™ preserves and guarantees all existing home equity so it is always available for these future funding needs, if and when required. This is not the case with reverse mortgages.
Retirees also need to look for the traps in traditional retirement income products and equity release products.
The pros 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:
- inflexible fixed long-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 your wealth management in retirement to an insurer – this comes at a 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 low risk and 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
- investment risk
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 money is locked up
- if early surrender is allowed at all, then it is very expensive with little or no return of capital
- poor investment returns
- fixed and 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 at a cost)
- some are now market-linked (but will not be tax-free)
- 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
- cost of guarantees
- insurer profit
- high costs of sale and commissions
There’s wisdom in an old industry saying … “annuities are sold, not bought“…
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
- compounding interest (not simple interest)
- amount released is entirely inadequate
- minimum borrower age 70 years old
- age limits the LVR
- LVR restrictions limit loan amount
- debt doubles every 9 -10 years
- depletion of 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
The insidious effects of compounding interest charges and resulting equity depletion, leaves most Retirees with insufficient home equity to fund their aged care accommodation bonds.
To sell a financial product to Retirees without this hidden and self-insured risk very clear 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, low care is required 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 future aged care needs.
Futureproof believes Retirees should always preserve their existing equity in the home and that reverse mortgages should never form a part of any responsible retirement plan.
Better outcomes for Retirees
Our 1st generation Futureproof products are built on the Equity Preservation Mortgage™. Our products work quite differently to deliver far better financial outcomes by overcoming the inherent defects in traditional retirement funding products.
Futureproof products have the following 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 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 mortgage insured
The average annuity amount released for a typical Retiree using an Equity Preservation Mortgage™ is $400,000 compared with just $80,000-$100,000 for a reverse mortgage.
How our retirement income products work
The 1st Generation of Futureproof products are built on our interest-only mortgage, 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 the 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 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 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 it back.
The Equity Preservation Mortgage™ is a variable-rate interest-only loan, so the loan principal is repaid from the estate upon death of the youngest Borrower or upon sale of the property, in the same way as a reverse mortgage.
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 use and monetize part of the stagnant, non-productive capital that is tied up in their home in this way provided:
- the home 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
- 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.