Equity release schemes have come a long way since the bad old days of the home income plan scandal of the 1990s. Today, with the growth in the membership of Safe Home Income Plans(SHIPs), better products and regulation by the FSA, lifetime mortgages and home reversions are now respectable products, which can play a useful role in some clients' retirement planning strategies.
The demographic changes driving the growth of equity release mean that the market is expected to grow to £2bn by 2010 according to the Actuarial Working Party.
Lower investment returns, poor annuity rates and increasing life expectancy, are resulting in many individuals reaching retirement with far less income from their pensions than expected.
At the same time, factors such as soaring house prices (the average house price in February 2007 was £192,233 according to Halifax), wealthier offspring (who are happy to see their parents spend their inheritance), aspirational lifestyles and the requirement for many individuals to pay their own healthcare and nursing home fees will continue to drive the equity release market for the foreseeable future.
Few retirees appreciate the effect of longer life expectancy. A man aged 60 today can expect to live on average another 23.8 years, while a woman of the same age can expect to live another 26.8 years.
A 65 year old male has a life expectancy of 19.5 years and a 65 year old woman 22.2 years (source Stephen Richards Consulting).
In 2005, there were just short of 570,000 deaths in the UK, with 66 per cent of these deaths occurring at age 75 or more, compared with just 12 per cent at the beginning of the 20th century.
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SHIP code of practice
SHIP was launched in 1991 to promote safe equity release schemes and today it has over 20 members including banks, building societies, IFAs and insurers.
All participating companies are entitled to use the SHIP logo on their marketing literature on condition that they adhere to the SHIP Code of Practice.
This binds member companies to:
- provide a fair, easy-to-understand presentation of their plans so that any scheme carrying the SHIP logo is properly explained and safe;
- ensure that the client’s solicitor, who oversees the transaction on their behalf, signs a certificate confirming that the essential features and implications of the equity release scheme has been properly explained to their client;
- no SHIP endorsed equity release plan will proceed without this certificate;
- provide a ‘no negative equity’ guarantee whereby the provider guarantees that the client will never be repossessed, even if the client’s outstanding mortgage on death exceeds the proceed of sale from the property.
Lifetime mortgages have been regulated by the Financial Services Authority since 15 October 2005 and any one selling these mortgages must be authorised by the FSA.
Under the SHIP code of practice, complaints about an equity release product you advised on, must be dealt with according to a strict timescale.
This includes a five day turn around for acknowledgement of the complaint, prompt investigation and regular updates on progress. If your client is unhappy with the outcome of this investigation, he or she can refer the complaint to the Financial Ombudsman Service (for FSA regulated firms). Home reversion plans will be regulated from 6 April 2007.
Cash can be released from a property in three principal ways, via:
- a lifetime mortgage,
- a home reversion,
- or by trading down to a cheaper property.
There are other forms of equity release, such as home income plans and shared appreciation mortgages, but these have proved to be risky to client, so these products will not be covered here.
A lifetime mortgage involves the client taking out a fixed rate, interest only, mortgage against the value of their property.
Your client pays no interest during their lifetime because the interest is rolled up and the entire loan (capital, plus interest) is repaid from the sale of the property on their death, or on moving into a residential nursing home, if earlier.
Example: 67 year old man, with 65 year old spouse own a property currently valued at £250,000. They take a lifetime mortgage of £50,000 at 5.99 per cent fixed rate of interest.
On second death after 20 years, the final cost of the loan (including rolled up interest) is paid from the proceeds of the property’s sale.
If the amount required to repay the mortgage exceeds the value of the property when your client dies, the lifetime mortgage provider will cover the loss and will never claim the excess from your client’s estate. This is because all SHIP members offer a ‘no negative equity’ guarantee.
However, if there is any equity remaining from the proceeds of the property’s sale after the mortgage has been paid off, this will pass to your client’s estate. This may occur if house prices have risen substantially, although there is no guarantee that this will happen.
The size of the mortgage (or cash facility) your client can raise will depend on their age, state of health and the value of the property at the time they apply.
Clearly, the younger and healthier they are, the smaller the sum they can borrow because of their longer life expectancy and the greater the chance of the entire equity in the property being exhausted.
How benefits are provided
A lifetime mortgage may provide:
- one-off cash lump sum;
- further cash lump sum drawdowns;
- a guaranteed income for life via an annuity;
- a combination of these lump sum/s and income
Although there are no monthly mortgage repayments to make, your client remains responsible for the repair and maintenance of the property and all household-related bills, such as council tax and service charges.
Some equity release providers offer a drawdown facility, whereby the client can choose to take an initial advance (from the total amount that is agreed they can borrow - called the ‘cash facility‘) and draw on this, as and when required. A new fixed rate of interest is agreed for each fresh advance.
This enables your client to hold down their cost of borrowing because they only pay interest on the funds they have actually drawn down, rather than having to pay compound interest on a large initial lump sum, which may be bigger than they really need.
If your client needs to move into a residential care home, most providers will insist that the house is sold and the mortgage redeemed (unless there is a spouse or another individual registered on the mortgage still living at the property, in which case the mortgage is redeemed on second death). However, a few providers will allow an individual or a couple to rent out their property while in a nursing home.
If your client wishes to move house, this is also possible, providing the new home meets the provider’s lending criteria and there is sufficient equity remaining in the existing property. However, your client remains responsible for all the costs of moving.
Another source of reassurance for your client, is that with a lifetime mortgage, your client keeps the house deeds.
The youngest client in the household must normally be over 60 years old to be eligible for equity release (but a few providers will accept those over age 55), but there is no upper age limit.
Cash released is tax free, but cash subsequently invested to provide an income or growth may be taxable. If the mortgage is repaid early (for instance if your client moves into care), there may be an early repayment charge.
The FSA is particularly keen that advisers consider the effect of equity release on any state benefits your client may receive, such as pension credit, council tax rebate and some care allowances (see below).
With a home reversion, your client sells a percentage share of the value of their property to a reversion company in return for a fixed lump sum, or an income for the rest of their life.
Your client continues to live rent free in the property for the rest of their life, but remains responsible for its repair and maintenance and all household-related bills. On death, the reversion company sells the property and receives the value of the percentage sold to it, while the client’s estate receives the value of the proportion of the property not sold by your client.
For instance, if your client sells 50 per cent of the value of a £250,000 property, they know that their estate will receive 50 per cent of the prevailing value of their property when they die. If the house is worth £500,000 on when they ide, their estate will receive £250,000.
By contrast, with a lifetime mortgage, it is impossible for the client to know at the outset how much equity, if any, will remain for their heirs, when the property is eventually sold. The price a reversion company will offer your client depends on their age, state of health and gender because the reversion company will be making a guess as to your client‘s life expectancy.
For example, a 67 year old man with a 65 year old wife, selling 50 per cent of a £250,000 property might receive around £43,750, although this could vary depending on their state of health and the condition of the property (Source: Home & Capital).
This example shows how the amount offered by a reversion company is likely to be significantly discounted (unless your client has a much reduced life expectancy due to very old age or infirmity). Home reversions will be regulated from 6 April 2007.
If your client is willing to move home, you should discuss the benefits of trading down, as this is the only way to extract the full market value from a property.
Over the next 25 years, the number of people of pensionable age is expected grow by 50 per cent to 15 million. These people will need additional capital or income in retirement, either because they face hardship in retirement or because they want to improve their quality of life.
The Institute of Actuaries estimates that there is £1,100 bn of largely untapped housing wealth owned by the over 65s and it is estimated that 4.3 m retired people could benefit by releasing equity from their homes. In 2006, the equity release market was worth around £1.5bn and this is expected to reach £3bn by 2012, according to SHIP.
Poor pensions, longer life expectancy and higher lifestyle expectations means that many of today’s pensioners want extra cash, not just to pay the household bills, but to maintain a decent standard of living and to be able to splash out on a few of life’s luxuries.
Attitudes to equity release
By age 60, retirees tend to have lived in their current home for an average of 15 years and few are willing to move from an area where they have been settled for years and are known in the community.
They are aware of the massive increase in house prices, but are generally reluctant to trade down because of the disruption it would cause. But some expect to sell their property at a later stage in order to trade down, buy a more manageable property or to emigrate.
Many of today’s retirees have children who are far better off than themselves and there is far greater acceptance by children that their parents should be able to use the family home to release cash, if it is needed, rather than bequeathing it as an inheritance. That said, many retirees still want to leave something for their children.
Most retirees prefer the concept of taking out a lifetime mortgage, because they are familiar with how mortgages work, whereas research shows they have difficulty understanding home reversions.
Research also shows that a common misconception among retirees is that equity release only provides a lump sum. However, even when the facility to take a regular income is explained to them, most still plump for a lump sum, although some recognise that a regular income could be useful for meeting nursing home fees.
This is because they want to ‘have control’ over their own money (rather than leaving it with the equity release provider). Others think they can get a better return by investing the lump sum themselves.
A few want to take lump sums to give money away (often to help grandchildren to buy a property) or to reduce the value of their estate for inheritance tax purposes. Retirees like the idea of paying a fixed rate of interest for the rest of their lives, although they are frequently unaware of how much they are being charged.
Key questions your clients are likely to ask
- What are the costs involved?
- What interest rate will I pay?
- Is this a fixed rate for life?
- How do you calculate how much I can release?
- Will this be via a lump sum only, income only, or a combination of both?
- What happens if I want to release more cash at a later date?
- What happens if the loan, plus interest, exceed the value of my property?
- What guarantees are there that my home won’t be re-possessed?
- Is the provider a member of SHIP?
- What happens if something goes wrong? Who can I complain to?
- Can I move house at a later date?
- What happens if my spouse dies?
- What happens if someone else comes to live with us? (ie sibling or other relative)
- What happens if one of us goes into care and the other wants to stay in the property?
- Is the provider a strong, trustworthy company with a good reputation which will still be in existence in 30 years’ time?
- Will I pay a penalty if I repay the mortgage early?
- How do you calculate this penalty. Does it apply indefinitely?
- Can I use my own solicitor to do the conveyancing?
It is advisable to encourage clients to discuss the idea of doing equity release plan with their family. Although no one is obliged to tell their children what they are doing with their own money, given the inheritance implications for their heirs, it is best that the family is aware of what their parents are doing, in order to avoid subsequent mis-selling claims.
Many children nowadays are significantly better off than their parents and are happy to see their parents enjoy their retirement and join the ‘skiers’ (pensioners who are ‘Spending the Kids’ Inheritance‘).
It is also advisable that clients consult their own solicitor, so that they have another source of independent advice, in addition to yourself.
Means tested benefits
Pension credit has been available to poorer pensioners since October 2003 and over half of pensioners are now in receipt of it, with take-up increasing every year. This, together with council tax benefit, are the two principal means-tested benefits.
There are prescribed FSA regulations which IFAs must comply with when advising clients, who are in receipt of state benefits, on equity release. These include the need to consider the following in your ‘reasons why’ letter:
• the client/s’ eligibility for benefits which are currently not being claimed (but could be in the future) and which may reduce or eliminate the need for an equity release plan; • an assessment of the interaction between the proceeds from the equity release plan and any means-tested benefits already being received.
If your client is receiving council tax benefit or pension credit, then any income or capital received from an equity release plan could affect your client’s entitlement to them.
Loss of state benefits could also mean your client having to pay more for dental treatment and glasses and losing the right to claim from the social fund. Your client might also have to pay for any care services being received or face an increased charge for such services.
Before making a recommendation, you must have reasonable grounds for concluding that the overall advantages of the plan you are recommending outweigh any loss of benefits.
This is a tax free, means tested entitlement for people aged 60 and over, who have only a modest income. The amount of pension credit a pensioner qualifies for depends on their income, savings and investments. Any savings over £6,000 are assumed to produce an income of £1 for every £500, or part of £500, over that amount.
Pension credit consists of two elements:
- A guarantee credit - to ensure a minimum income for a single person aged 60 and over of at least £114.05 per week (2006-07) or £174.05 per week for couples (the amounts are higher for some disabled people, carers and people with certain housing costs).
- A savings credit - which rewards individuals aged 65 and over who have modest pensions. This can be worth up to £17.88 per week for a single person and £23.58 per week for couples (2006-07). It can be paid in addition to the guarantee credit, or on its own for people with income that is too high to receive the guarantee credit.
If your client is receiving pension credit and has been given an ‘assessed income period’ (which is normally for up to five years), changes to your client’s income and savings may not be taken into account until the end of that period, although your client is required to inform their local benefits office of any changes in their financial circumstances during the five year period.
Entitlement to a rebate on council tax for older people, like pension credit, is based on the level of their income, savings and other circumstances. Normally, council tax benefit cannot be claimed if your client’s savings are £16,000 or more. If your client has savings of between £6,000 and £16,000, council tax benefit is granted on a sliding scale.
However, these limits do not apply for anyone receiving the guarantee element of the pension credit. In addition, the single occupant’s 25 per cent discount is not based on income and savings at all, and so will not be affected by a lifetime mortgage.
Key points to remember on state benefits
- If a cash lump sum from a lifetime mortgage increases your client’s savings to more than £6,000 savings in total, this may reduce the benefits they are entitled to or stop their eligibility for benefits altogether
- Any additional income from a regular income plan or home reversion annuity may also reduce their benefits.
- Council tax benefit will be reduced by an amount equal to 20 per cent of the income your client receives. For instance, if their equity release income is £50 a week, their council tax benefit will be reduced by £10 per week.
How equity release interacts with state benefits in practice
Although, cash lump sums and income generated by an equity release plan are tax free at the point of receipt from the provider, they may become taxable if they are invested by your client.
How equity release interacts with state benefits in practice
Thi is not straightforward because there is little uniformity of practice across different benefit offices.
For instance, the treatment of cash lump sums taken for immediate expenditure is a grey area. If, say, £10,000 is deposited in a bank or building society account for immediate expenditure, will it count towards your client’s savings when they are being assessed for means tested state benefits?
Some benefits offices say that a £10,000 lump sum will not affect benefit entitlement, providing the money is spent within one month (for instance for home improvements).
Other benefits offices have ruled that the moment the money lands in your client’s bank account, it forms part of their savings and will count towards the £6,000 savings limit.
Also supposing (in scenario one above), cash for immediate expenditure is unintentionally left on deposit for six months because your client’s builders fail to turn up. The benefits office which was willing to turn a blind eye to a short term deposit may well include it after six months, in which case your client’s entitlement to state benefits might be jeopardised.
Because there are no firm guidelines, it is strongly recommended that your clients contact their local benefits office to ascertain how the money from the equity release plan you are recommending will be assessed with regard to their entitlement to means tested state benefits.
For further information, Age Concern provides fact sheets and booklets on entitlement to benefits.
Last edited March 2007