In Downsizing on Wednesday 17th Apr, 2019

How to use your home equity to create a bigger retirement income

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Retirees who were fortunate or foresighted enough to have purchased homes in areas that have rocketed in value, such as Sydney’s Bondi, above, are sitting on a tidy nest egg.

Almost half of older Australians retire without enough superannuation to fund a comfortable retirement without some recourse to the Age Pension.

If that sounds like you, you’re not alone; 43 percent of Starts at 60 readers receive a part- or full pension. It’s no big surprise – after all, today’s retirees were already well into their working lives when the Superannuation Guarantee scheme came along in 1992 and at 3 percent, the original mandatory employer contribution wasn’t high.

But successive governments have progressively tightened restrictions around pension eligibility, including in 2015, when the Coalition government cut the amount of assets older Australians could hold and still receive a part-pension. (The government had also proposed a reduction in pension indexation to the level of inflation – a change it didn’t succeed in introducing.)

More recently, it extended the Pensions Loan Scheme, a move that some commentators saw as a further sign of intent to reduce the cost of the pension to public coffers.

Should you be worried about the future of the pension or are finding it difficult to live the lifestyle you choose on your current income, though, the government has proposed a solution; downsize your home and place the freed-up funds into superannuation to increase your tax-free income.

The logic seems pretty simple. Your biggest asset by far is likely to be the family home, particularly given the fact that house prices in many Australian cities have gone through the roof over the past decade or so. You probably don’t have dependents living with you any longer, so don’t need as much space. And even contributing a relatively small additional sum to your super balance has the potential to create enough income to, say, fund a nice holiday every year, so sell up and enjoy a little more luxurious retirement, the argument goes.

Bryan Ashenden, BT’s head of financial literacy and advocacy, says downsizing is definitely an option retirees should give some serious consideration – at very least, to be certain that their choice of the comfort of home over a more carefree lifestyle is one they’re happy with.

“If people have put money into the family home and they don’t have substantial other assets, then by retaining the family home, you are going to give up a lifestyle,” Ashenden points out.

“Yes, you’ve got somewhere you’re really comfortable to live, but do you have enough money saved in super or through other methods to fund your retirement lifestyle?”

Before deciding whether downsizing to boost your retirement income is an option for you, though, it’s important to understand how the process works, particularly given that it may impact your pension entitlement. We’ve set out the basics in this story, but you shouldn’t make such a major decision without talking to a financial adviser to ensure you’ve covered every possible outcome.

Downsize your house, upsize your super

Usually, reaching age 65 means the end of the road in terms of being able to put money into super, unless you meet the Department of Human Services’ work test, which you can read more about on its website.

But following changes announced in the Budget 2017/18, older Australians who sell their family home can make a substantial super contribution from the proceeds, regardless of their age.

“If you meet all the qualification criteria, then you can sell your main residence and put up to $300,000 per person into superannuation. If you’ve got a couple, that’s $300,000 each,” Ashenden explains.

“Other than having to meet the requirements of being at least age 65, having owned the property for at least 10 years and the property qualifying for some exemption from capital gains tax, there are no other qualification criteria.”

Ashenden suggests the money contributed to your super balance could then be used to commence payment of a tax-free pension from the fund in the form of an account-based pension, providing a retirement income boost that may be welcome for retirees who presently rely wholly or largely on the pension.

How the downsizing rule works in real terms

Let’s use Mary as an example of how downsizing can be used to increase a retirement income. She’s not a real person but she has traits in common with many retirees – they didn’t have the opportunity to build a big super balance while they were working, perhaps because they were self-employed or spent time out of the workforce raising a family. What they do have, though, is money they’ve saved in the family home over the decades.

Mary didn’t have a lot of super when she retired at the age of 65 and now, at 77, her super balance is at zero because she’s been using it to create a small income to top-up her pension entitlement. She doesn’t have a lot of expensive belongings, just $10,000 worth of home contents and a $20,000 car, and has about $10,000 in emergency funds in her bank account.

Mary’s home is worth about around $550,000, so she decides to sell it and move to a smaller property nearby, freeing up some of her home equity. After the costs of selling, then buying her new home, Mary has $150,000 left.

Taking advantage of the new downsizing rule, she contributes the full amount to her super balance and starts to draw down on the money as an account-based pension.

Mary’s able to draw a tax-free pension of $9,000 per annum from her super, without affecting her Age Pension entitlement because her income and assets come in under the thresholds set by the Department of Human Services. You can read more about the income and assets tests at the department’s website by clicking on the links we’ve embedded.

Mary chose to draw $9,000 in annual income because that’s equivalent to 6 percent of her total super balance of $150,000; 6 percent is the minimum percentage of her balance she’s permitted to draw down under the rules governing super income streams. The minimum percentage is dictated by your age, which the Australian Taxation office explains in detail.

Before downsizing, with her original, small super balance having run out, Mary received the full, single Age Pension at the current rate of $926. 20 per fortnight, giving her an annual income of $24,081 a year.

After downsizing, her income jumps to $33,081 a year, making a substantial difference to her lifestyle.

Other things to think about

Mary’s outcome is a positive one. But there are a couple of points you also need to think about if you’re looking at taking advantage of the downsizing rule. First, you only get one shot! You can’t repeat the exercise in ten years’ time.

You’ve also got only got 90 days from the day you receive the proceeds of your property sale (usually settlement day) to make the contribution to superannuation.

And if you elect for an account-based pension, from which you drawn down a specific amount each year in income while the balance remains investment, there’s no guarantee that your balance will grow, so you can’t be assured that your annual income boost will last longer than it takes to draw down the total balance, minus any fees your super fund may charge.

Finally, there’s no guarantee the downsizing rule will be around forever either. Governments change the rules on super relatively frequently so if there’s always the possibility this opportunity won’t survive another shake-up of the super system.

Things you should know: Westpac Banking Corporation ABN 33 007 457 14 AFSL and Australian Credit Licence 233714 (Westpac). Information is current as at [July 2018]. This information does not take into account your personal circumstances and is general in nature. It is intended as an overview only and it should not be considered a comprehensive statement on any matter or relied upon as such. Before acting on it, you should seek independent financial and tax advice about its appropriateness to your objectives, financial situation and needs.

Have you considered using the equity in your home to improve your retirement lifestyle in some way? Or do you prefer to keep the funds in your home for a rainy day?

Important information: The information provided on this website is of a general nature and for information purposes only. It does not take into account your objectives, financial situation or needs. It is not financial product advice and must not be relied upon as such. Before making any financial decision you should determine whether the information is appropriate in terms of your particular circumstances and seek advice from an independent licensed financial services professional.

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