Retirement and the family home
The family home is a residential property. But it is also a financial asset. In fact, 43% of household wealth is contained in family homes. What's more, the twenty-year average return on residential Australian property to 31 December 2017 was 10.2%. The average age of retirement for a man is 63 years and for a woman is 59 years. The life expectancy for anyone who reaches the age of 65 is 84 for men and 86 for women. This means that the average duration of retirement is well over 20 years - a period over which the value of the home has historically tripled. So, the family home remains a very important asset in retirement.
Financial Planning, Retirement and the Family Home
One of the key benefits of a family home is that its value is exempt from calculations used to determine Centrelink aged pension benefits. In addition, if and when an owner needs to move into an aged care facility, only a portion of the family home is counted in the assets test used to calculate the means tested components of the accommodation and care costs.
This is usually a good reason for older people to retain the family home, even beyond the point when they move into aged care.
That said, family homes are relatively large, single assets with a particular feature: they do not produce income (although they do remove the need to pay rent, which is an income-like benefit). It is this income feature (or lack of income feature) that is often the most pressing issue to be addressed when it comes to home ownership.
The Best of Both Worlds - Asset-Rich and Cash-Rich
In the perfect retirement world, the lack of income generated from family homes does not matter. Other elements of the financial profile, and in particular superannuation, can be used to finance day to day expenditure. The family home sits neatly within a broader financial profile, providing housing for minimal outlay and continuing to provide substantial capital growth in the most tax-advantaged way.
In this world, the client is able to retain their family home throughout their retirement.
A Common Dilemma - Asset-Rich, Cash-Poor
Unfortunately, not everybody has done this well. Many people own their family home and not much else. This can lead to a common retirement problem of being 'asset-rich but cash poor.' For some people, this situation can lead them to consider 'downsizing' the family home, whereby they sell their current home and then buy another home for some smaller value. This frees up cash to finance lifestyle.
Sometimes, downsizing works well. For example, where the new home entails lower maintenance or is better located, the retiree gains a double benefit: they have more money to spend and a preferred place to live.
But if done for purely economic reasons, downsizing should be seen almost as a last resort when it comes to funding a retirement. In this following section, we examine various benefits of downsizing. Before we do that, however, let's examine the inherent risks in downsizing.
The Risks of Downsizing
While the lure of increased spending money can encourage people towards downsizing, downsizing is not without its risks. These risks include the following:
High Transfer Costs. Depending on which state you live in, the costs of selling one home and buying another are substantial. For example, selling a property in Victoria for $600,000 will cost between $12,000 and $18,000 in agent's fees (source: Choice magazine). Purchasing a new property for $400,000 will lead to $19,000 in stamp duty (source: State Revenue Office). Add in another $3,000 or so in costs (legal, removalists, etc) and the changeover cost will be somewhere between $34,000 and $40,000). so, selling one home for $600,000 and buying another for $400,000 does not give rise to actually receiving an extra $200,000 in cash. The cash benefit is no more than $166,000.
The 'cheaper' house may not be cheaper. When downsizing, most people are moving from a house they know well to one that they do not know at all. This can lead people to experience unexpected costs that seriously eat into any money that has been 'freed up' by the move. These costs can include unknown faults that need to be rectified, or just simple modifications to bring the home up to a standard that the new residents enjoy.
The home is an exempt asset for Centrelink purposes. Cash is not. So, unless the amount of freed-up cash is less than the threshold, there will be a change to the asset-tested Centrelink pension amount. Swapping house for cash can reduce pensions.
Reduced Future Capital Growth. The twenty-year average return on residential Australian property to 31 December 2017 was 10.2%. The example change, above, from a $600,000 home to a $400,000 home, would have therefore 'cost' almost $20,000 a year in lost capital growth (9.8% of $200,000).
As capital growth is a percentage, it follows that reducing the value of the residential property being held will reduce any future capital growth that will be available. The average age of retirement for a man is 63 years and for a woman is 59 years. The life expectancy for anyone who reaches the age of 65 is 84 for men and 86 for women. This means that there is a good chance that a women retiring at 59 faces another 27 years (on average) in which to finance her retirement. Imagine the negative effect of downsizing on capital growth extrapolated out over 27 years.
Because retirements can be long, the early years of retirement, in particular, are years in which it is most beneficial that a person try to continue to accumulate as much wealth as possible. Downsizing early in retirement can make the later stages of retirement difficult.
If the new home is cheaper, there may be a reason. Amongst other things, the price of homes tends to be a function of demand. So, if the new home is cheaper, this is because fewer people want to buy it. The client needs to ask why this is the case. Is the new home further from amenities, such as shops and, importantly, health care? (Retirement does have an inevitable conclusion, after all).
It is not unusual to observe people moving to a cheaper area earlier in retirement, only to find themselves unable to afford to move back to their original area years later when health or family needs make the new home no longer appropriate. This can be a particular problem for sea or tree changers.
Of course, the new home might also simply be cheaper because it is not as good as the old one.
Moving out of the current area can have unexpected consequences. Many people find that moving to a new area is not as easy as they expected it would be. One relatively common tale is where a couple move in retirement, only for one of them to die sooner than expected. This then leaves the surviving member of the couple living some distance from friends and family and finding it difficult to make new friends in the new location. Widows, in particular, often tell the tale of no longer being invited to socialise after their husband has passed away.
Alternatives to Downsizing
The appeal of downsizing lies in the cash that it frees up. This cash can then be used to finance retirement activities. It follows, then, that other strategies that make spending money available to a retiree should be considered as alternatives to downsizing. Potential strategies include (the links open up to substantial discussions about each strategy):
- Working longer (ie deferring retirement, using a transition to retirement pension or retiring gradually);
- Working longer AND superannuating heavily;
- Reverse mortgages;
- Centrelink's Pension Loan Scheme (a scheme that is available to people receiving something less than the full aged pension);
- Home reversion strategies;
- Inviting in a housemate with whom to share costs;
- Reducing costs, such as car costs (NB: car costs can increase after downsizing if the new area is not close to amenities or public transport); and/or
- Renting out the current home and then renting a cheaper home yourself, using the difference to finance lifestyle (this will affect the income test, but will preserve the higher asset base). This solution can often be the best one for people contemplating a seachange or treechange, where they are moving to an umfamiliar area. Even spending a year or two renting, while you check out the new area to see if you really do want to live there long-term, can be a really good move.
Estate Planning and Inter-Generational Planning
As outlined above, recent experience has been that median house prices have tripled over the average 20 year plus retirement. This means that retaining the family home has a substantial impact on both estate planning and inter-generational financial planning. Put very bluntly, the more home a retiree owns, the greater the amount that can be distributed to their estate when they die.
Similarly, a retiree who owns a home is typically in a better place to provide assistance to younger generations who might need it. It is easier, for example, for a person with substantial real estate assets to offer a guarantee of a child's loan.