U.K.. New Ways to Pay for Old Age

LONDON (Financial Times), January 14, 2005: The most valuable assets you are likely to own at retirement are your pension fund and your home. With retirement now often lasting more than 20 years, it makes sense to draw on both sources for capital and income. While we are living longer, we are saving less in our pension schemes, so the need for additional sources of retirement income is growing. Research from the Institute of Actuaries, published this week, says about 4.3m retired people could benefit from the use of equity release to bridge the gap between available income and actual needs. It estimates that £1,100bn of largely untapped housing wealth is owned by the over 65s. Equity release schemes allow you to borrow against your house value or sell a portion of the property outright. The institute believes the market could treble in size in the next few years as it becomes more relevant for “middle England” and even for wealthy homeowners with potential inheritance tax issues. The vast majority of equity release schemes used to be “distressed sales” to elderly people desperate for cash. In the past, most of these schemes have required users to take a single lump sum upfront. But equity release schemes are becoming more flexible as companies look to tap into this growing market. From next month, the option to use your home as an intermittent source of extra cash will become available from Just Retirement, a recently launched life office. Its scheme will be sold only through financial intermediaries, and financial advisers expect other companies to launch similarly flexible schemes. Just Retirement's scheme is unusual in two ways: ■ It is a “fixed lifetime mortgage”, so the debt is fixed at the outset and includes all future interest payments no matter how long you live. Although this means the debt is initially comparatively large, the debt is guaranteed never to increase. With the more common roll-up schemes, the initial debt does not include interest payments and so is lower. But the final debt is unknown and will depend on how long you live because the interest is compounded and added to your mortgage debt. ■ The new scheme is designed to allow borrowers to take additional loans from as little as £5,000, whenever required, which means you can tailor these loans to your changing needs in retirement. With a roll-up mortgage you may be able to negotiate a further loan, but normally you have to wait at least five years. Even then the lender will look closely at your total accumulated debt and house value before making a further advance. This week the charity Age Concern also launched an innovative scheme a branded version of a Northern Rock roll-up mortgage. Age Concern has negotiated competitive terms and its scheme is particularly attractive to poorer pensioners because it offers a comparatively low rate of interest and can be arranged on properties worth as little as £30,000. Its equity release scheme is also unusual because it offers a monthly income option direct from the lender. The income is in effect a series of fixed regular loans. This lacks the flexibility of the Just Retirement drawdown feature but could be very attractive for low-income pensioners. It is not an annuity, so although it is intended that the income will last an average lifetime, there is a risk that your income stream could run out if your retirement lasts many years. Ruth Clarke, marketing director at Age Concern, says: “Equity release is . . is going to form part of a sensible financial planning strategy for a growing number of pensioners. For many, the prospect of trading down [their property] is unattractive as they are emotionally attached to their home and neighbourhood, and the cost and stress of the move can outweigh the benefits.” Schemes that allow you to draw a regular income or intermittent lump sums are more tax-efficient than those that pay you a single lump sum, where your intention is to invest this to generate income. Mike Wadsworth, partner with the actuarial firm Watson Wyatt, says: “In principle you should only draw what you need. If you take a large lump sum and invest the bulk of this, there will be a significant differential between the gross interest rate you pay the equity release provider and the net return you can achieve from a high-interest deposit account, for example.” Mike Fuller, chief executive of Just Retirement and a founding member of the self-regulatory body, Safe Home Income Plans (Ship), argues that, with share prices depressed, it can be wiser to draw an income from your home than from your pension fund. “Over the past five years, residential property has more than doubled in value relative to equities, but this trend cannot continue,” he says. “If you draw down from your pension fund, this would involve selling equities while prices are still depressed, but if you draw on your home you are cashing in when its value may have peaked.” Most equity release schemes that roll up debt usually have a “no negative equity” guarantee, so the most you can owe is the value of your property. But this may be cold comfort for those with high-value houses who are borrowing only a small percentage of their property's value. If you are concerned that you might live much longer than average life expectancy, you might do better with an equity release scheme where the total mortgage debt remains static, regardless of how long you live. This is particularly important because current benefit illustrations for equity release schemes assume only average life expectancy. Longer illustrations would highlight the risks of these schemes if you survived to a ripe old age. Furthermore, illustrations do not show how quickly debt is likely to increase on your mortgage where interest is added to your outstanding debt. Fuller points out that, with compounding interest, assuming a 7 per cent borrowing rate fixed for life, a £100,000 loan will double to £200,000 after 10 years. After 30 years and the more affluent you are the longer you are likely to live the debt would be £800,000. These examples highlight the potential risks of some equity release schemes, particularly if you live for a long time. However, schemes have improved a lot since some were mis-sold in the late 1990s. With tougher regulation and an expected influx of new schemes, equity release is likely to be considered more seriously. By Debbie Harrison YOUR MONEY