Homeowners with reduced pensions have two main options for increasing their standard of living
Your home is likely to be your greatest asset and for many people, property plays a huge role in retirement planning.
Dwindling pensions make unlocking cash from property an increasingly popular option, but for those who have the equity, is it better to sell up and downsize, or should retirees opt for to equity release plans?
If you're asset rich but cash poor, it seems sensible to tap into any money that is tied up in your home. Financially, downsizing is the obvious choice.
"Generally speaking, I'm quite negative on equity release. It's a very expensive way to release capital and downsizing is much more flexible," says James Sumpter from independent financial adviser (IFA) Bestinvest. "You can invest the money in such a way that you can draw an income from it with the freedom to access that capital if you need it, while better preserving the value of your estate."
The big benefit with downsizing over equity release is that you retain ownership of your property. This means you can pass it on to your family when you die. You can usually raise more money by downsizing because equity release companies value your home at below its market value. Moving into a more manageable property should mean lower running costs and, above all, this is a way to release money without incurring any debt.
Downsizing still has its problems, however. First and foremost, you might not sell your home for as much as you hope. Even if you do, all the costs associated with selling property, such as estate agency fees, valuation fees, stamp duty, legal fees and general moving costs, will take a large chunk out of any profit.
"You need to be sufficiently high on the property ladder to be able to downsize, while also being aware that in a falling market a larger house will tend to have fallen in value more than a smaller house," says Vanessa Owen, the head of LV= equity release.
Decisions are often emotional as well as financial, and the big selling point with equity release is that you can stay in your home. The thought of having to move out of a well-loved home and downsizing, which could also mean moving away from family and friends, is the last thing many older people want to consider.
With equity release you can use the equity in your home to raise capital without having to move or make monthly repayments. It is available to homeowners aged at least 55 and there are two types of plan to choose from: home reversion plans and lifetime mortgages.
Most people opt for lifetime mortgages. These can roll up so that there are no monthly repayments; instead interest is added to the loan and paid at the end of the term (usually upon death or movement into long-term care). With home reversion plans, equity is released through selling all or a percentage (from 25 per cent) of your property, which can help in terms of inheritance tax planning because you are effectively reducing the size of your estate.
The share that you can access will depend on your age; the older you are, the more you'll get. And again, you can opt for a lump sum, or an income stream. You retain the right to stay in your home until death (although both lifetime mortgages and home reversion plans can usually be transferred if you decide you want to move). When you come to sell the property, the home reversion company takes its percentage of the sale proceeds.
The big problem with lifetime mortgages is that you don't know how much you could lose in interest – unless you can predict your own death – and there could be a huge bill when the company claims its original loan and interest from the sale of the property. If your home was valued at £500,000 and the loan was £200,000, an income of 4 per cent would give you £8,000 per year, but 7 per cent interest over 25 years will cost a staggering £350,000 in interest. If you had compound interest to contend with too, as with many equity release plans, you could be in real trouble, particularly if your circumstances changed and you needed money for care fees, for example. You could find that there is very little equity left.
You can pick a scheme with a "no negative equity guarantee" – choose a member of trade body Safe Home Income Plans (Ship) – so that you'll never owe more than your home is actually worth. You can also save money on interest by choosing to take cash in instalments and pay interest only on what you actually use.
"There are schemes available where the homeowner can release extra cash in future years should they need to. With a flexible drawdown scheme, you are able to take a lump sum from the outset and then borrow more when it's required," says Ms Owens.
With home reversion, the big problem is that these firms do not offer you the full market value of your property. For example, you might want to release £50,000 from your £500,000 property but instead of 10 per cent, they might insist on owning 20 per cent. Releasing cash from your home in this way may also affect your entitlement to state means-tested benefits so it's important to take independent legal and financial advice with any equity release plan.
Downsizing may be the cheapest and most transparent option then, but if you have time on your side, it is far better to avoid relying on your home to fund your retirement altogether. "Those in their mid-60s now who perhaps bought 25 years ago have seen tremendous increase in house prices. Many haven't made any other retirement provisions but they can rely on large equity in their home," says Mr Sumpter.
Today, however, the outlook for the property market is troubled, and using property as the sole retirement vehicle is a very dangerous tactic even for people with a reasonable amount of equity in their home. Looking back to 2008, there were people reaching retirement who didn't have large enough pension pots to survive and needed to downsize but found they couldn't sell at the price that they wanted, or even at all. And, those wanting to downsize are usually moving from a house to a flat or bungalow, which is far more difficult in a stagnant market than moving from flat to flat.
"A large percentage of my clients are looking to downsize from, say, a four or five-bed house to a more manageable and cheaper to run property," says Trevor Kent, a Gerrards Cross estate agent and former head of the National Association of Estate Agents.
"There are fees, of course, and stamp duty to factor in, and economic slowdowns can be a real stress on buying chains. Also, the prices of smaller properties such as bungalows are robust – in part buoyed by buy-to-let – which is the type of property downsizers are looking at," he said.
And the general economic woes can also potentially throw a spanner in the downsizer works. "We could be in a recession for a number of years, or at least very slow growth, and in that environment the number of buyers will diminish. When you're uncertain about job prospects you're less inclined to upscale and move to a better property," says Minesh Patel from IFA EA Financial Solutions.
The current economic situation has highlighted just how dangerous it is to be wholly reliant on property. It can work in combination with more effective retirement planning and other investment vehicles such as ISAs, but the underlying message from many financial advisers is simply that you may have to face retiring much later than you might hope.
"We have to adopt a less conventional model of retirement. The reality is that the majority of us could spend 30 years in retirement so the idea of total retirement is not achievable. The more successful retirees that I deal with continued in some form of limited work," says Mr Patel.
Expert View
Vanessa Owen, LV=
"The equity locked in your home should be a prime consideration when planning your retirement. Planning ahead and discussing every available option is key to securing a comfortable retirement. People can look at downsizing to release the equity in your property, or this can also be done through an equity release plan if you want to remain in your current home."
If you're asset rich but cash poor, it seems sensible to tap into any money that is tied up in your home. Financially, downsizing is the obvious choice.
"Generally speaking, I'm quite negative on equity release. It's a very expensive way to release capital and downsizing is much more flexible," says James Sumpter from independent financial adviser (IFA) Bestinvest. "You can invest the money in such a way that you can draw an income from it with the freedom to access that capital if you need it, while better preserving the value of your estate."
The big benefit with downsizing over equity release is that you retain ownership of your property. This means you can pass it on to your family when you die. You can usually raise more money by downsizing because equity release companies value your home at below its market value. Moving into a more manageable property should mean lower running costs and, above all, this is a way to release money without incurring any debt.
Downsizing still has its problems, however. First and foremost, you might not sell your home for as much as you hope. Even if you do, all the costs associated with selling property, such as estate agency fees, valuation fees, stamp duty, legal fees and general moving costs, will take a large chunk out of any profit.
"You need to be sufficiently high on the property ladder to be able to downsize, while also being aware that in a falling market a larger house will tend to have fallen in value more than a smaller house," says Vanessa Owen, the head of LV= equity release.
Decisions are often emotional as well as financial, and the big selling point with equity release is that you can stay in your home. The thought of having to move out of a well-loved home and downsizing, which could also mean moving away from family and friends, is the last thing many older people want to consider.
With equity release you can use the equity in your home to raise capital without having to move or make monthly repayments. It is available to homeowners aged at least 55 and there are two types of plan to choose from: home reversion plans and lifetime mortgages.
Most people opt for lifetime mortgages. These can roll up so that there are no monthly repayments; instead interest is added to the loan and paid at the end of the term (usually upon death or movement into long-term care). With home reversion plans, equity is released through selling all or a percentage (from 25 per cent) of your property, which can help in terms of inheritance tax planning because you are effectively reducing the size of your estate.
The share that you can access will depend on your age; the older you are, the more you'll get. And again, you can opt for a lump sum, or an income stream. You retain the right to stay in your home until death (although both lifetime mortgages and home reversion plans can usually be transferred if you decide you want to move). When you come to sell the property, the home reversion company takes its percentage of the sale proceeds.
The big problem with lifetime mortgages is that you don't know how much you could lose in interest – unless you can predict your own death – and there could be a huge bill when the company claims its original loan and interest from the sale of the property. If your home was valued at £500,000 and the loan was £200,000, an income of 4 per cent would give you £8,000 per year, but 7 per cent interest over 25 years will cost a staggering £350,000 in interest. If you had compound interest to contend with too, as with many equity release plans, you could be in real trouble, particularly if your circumstances changed and you needed money for care fees, for example. You could find that there is very little equity left.
You can pick a scheme with a "no negative equity guarantee" – choose a member of trade body Safe Home Income Plans (Ship) – so that you'll never owe more than your home is actually worth. You can also save money on interest by choosing to take cash in instalments and pay interest only on what you actually use.
"There are schemes available where the homeowner can release extra cash in future years should they need to. With a flexible drawdown scheme, you are able to take a lump sum from the outset and then borrow more when it's required," says Ms Owens.
With home reversion, the big problem is that these firms do not offer you the full market value of your property. For example, you might want to release £50,000 from your £500,000 property but instead of 10 per cent, they might insist on owning 20 per cent. Releasing cash from your home in this way may also affect your entitlement to state means-tested benefits so it's important to take independent legal and financial advice with any equity release plan.
Downsizing may be the cheapest and most transparent option then, but if you have time on your side, it is far better to avoid relying on your home to fund your retirement altogether. "Those in their mid-60s now who perhaps bought 25 years ago have seen tremendous increase in house prices. Many haven't made any other retirement provisions but they can rely on large equity in their home," says Mr Sumpter.
Today, however, the outlook for the property market is troubled, and using property as the sole retirement vehicle is a very dangerous tactic even for people with a reasonable amount of equity in their home. Looking back to 2008, there were people reaching retirement who didn't have large enough pension pots to survive and needed to downsize but found they couldn't sell at the price that they wanted, or even at all. And, those wanting to downsize are usually moving from a house to a flat or bungalow, which is far more difficult in a stagnant market than moving from flat to flat.
"A large percentage of my clients are looking to downsize from, say, a four or five-bed house to a more manageable and cheaper to run property," says Trevor Kent, a Gerrards Cross estate agent and former head of the National Association of Estate Agents.
"There are fees, of course, and stamp duty to factor in, and economic slowdowns can be a real stress on buying chains. Also, the prices of smaller properties such as bungalows are robust – in part buoyed by buy-to-let – which is the type of property downsizers are looking at," he said.
And the general economic woes can also potentially throw a spanner in the downsizer works. "We could be in a recession for a number of years, or at least very slow growth, and in that environment the number of buyers will diminish. When you're uncertain about job prospects you're less inclined to upscale and move to a better property," says Minesh Patel from IFA EA Financial Solutions.
The current economic situation has highlighted just how dangerous it is to be wholly reliant on property. It can work in combination with more effective retirement planning and other investment vehicles such as ISAs, but the underlying message from many financial advisers is simply that you may have to face retiring much later than you might hope.
"We have to adopt a less conventional model of retirement. The reality is that the majority of us could spend 30 years in retirement so the idea of total retirement is not achievable. The more successful retirees that I deal with continued in some form of limited work," says Mr Patel.
Expert View
Vanessa Owen, LV=
"The equity locked in your home should be a prime consideration when planning your retirement. Planning ahead and discussing every available option is key to securing a comfortable retirement. People can look at downsizing to release the equity in your property, or this can also be done through an equity release plan if you want to remain in your current home."
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