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What Are We Saving For?

What Are We Saving For? Using Assets in Retirement

The purpose of this article is to stimulate discussion around finances in retirement. It is not meant to be financial advice, nor should it be taken as such. We recommend you seek advice from a professional before making any major financial decisions.

Throughout our lives we accumulate assets in the form of money, housing and all kinds of possessions. What for? Do we draw down on our wealth to preserve our standard of living in old age; keep it for a “rainy day”; or leave it as an inheritance?

What assets do older people have?

  • Superannuation and pensions

The value of entitlements to New Zealand Superannuation (NZS) can be seen as an asset, although we can’t turn this into ready cash.  On retirement, or when they reach 65, some people receive pensions or lumps sums from private or occupational pension schemes and  many more will get cash from KiwiSaver, as their schemes mature. Lump sums can be invested, used to clear debt, or spent. Often people use the money for home improvement, to replace cars or major household items or to take that “trip of a lifetime.” What are people going to do with their  KiwiSaver lump sums, which may be more money than they have ever seen in their hands before?  There is no requirement at present for it to be invested. What happens if they fritter it away? Or invest it unwisely? It will be an individual decision what to do.

Bear in mind that not everyone will get lump sums from KiwiSaver. Many people either can’t afford or choose not to contribute to the scheme. Many will have gaps in their working lives for caring responsibilities, study, illness or unemployment. Some will have chosen a KiwiSaver scheme which has not done well – whose fault is that?

  • Financial investments

Something like half of people aged 65 and over have income from investments, reflecting lifetime savings, but this source accounts for only a small proportion of income, especially given the very low interest rates which can currently be obtained from bank deposits and savings accounts.

  • Residential property

Home ownership is the most common form of asset holding in this country. Three-quarters of people aged 65 or over live in owner-occupied housing, the majority mortgage free. Only a very small proportion own rental property, so rents are not a significant source of income overall.

The majority of older New Zealanders, therefore, have a substantial asset in the form of their homes, which have been growing in value, especially recently. The average house price over the whole country is close to $700,000, substantially more in Auckland. Home ownership also represents a lifetime of saving.

 

What can we do with these assets?

For most older people, NZS provides a basic income, supplemented by other regular pensions and income from savings and investments. With careful management by individuals and good consumer protection, this can deliver a fairly comfortable lifestyle, if they are outright homeowners. But, having a financial nest egg for unexpected costs will help to give peace of mind and to ensure that older people don’t go without essentials.

This is fine for “liquid” assets (bank deposits, bonds, and shares) which can be realised comparatively easily. Money tied up in our homes is harder to mobilise.

 

Mobilising wealth tied up in housing

If we had saved $700,000 through our lifetime why wouldn’t we use the money to make our retirement years more enjoyable and comfortable? Many older people are sitting on funds of this order in the value of their mortgage-free homes.

 

Preserve or mobilise

First of all, people must decide if they want to preserve funds tied up in housing or mobilise them in some way. Most people do nothing and by default their capital is kept intact, probably growing as house values increase. In this case, the equity is preserved for inheritance after the owners die.

Home equity can be used as security for a loan when a special need arises, such as medical emergencies; perhaps paying for surgery in a private hospital rather than suffering pain for months on a waiting list; or financial difficulties facing family members – a marriage breakdown, business failure, redundancy, sudden death or illness. This approach may be described as ‘saving it for a rainy day”.

Less dramatically, older people may wish to assist their grandchildren to purchase a house or undertake tertiary education. In some situations, home equity may be required to pay for long-term residential care.

 

Releasing housing wealth

In this case the first decision is whether to remain in the home. If the home is sold, part of the capital may be released by ‘trading down’ to cheaper housing, more suited to the needs of a smaller household. Moving into a retirement village may have this effect. Many people successfully trade down in, or approaching, retirement.

By selling, all of the home equity is released to spend or reinvest. But this means that the former owners must find somewhere else to live, incurring the costs of renting. They will have to balance returns from investing the proceeds against the costs of alternative accommodation. Renting removes the burden of home maintenance, but can bring reduced security of tenure, rent increases, and less freedom to alter the housing.

Moving in with family members can provide care and support as well as accommodation. It could be an alternative to residential care and will preserve capital for inheritance. However, this does not appear to be a favoured option among the majority of older people in New Zealand. The downside of moving in with family members includes loss of autonomy and potential family problems.

Several other options allow owners to remain where they are, in familiar home and community surroundings. They can share – taking in boarders or flatmates. Large family homes may be converted into flats. These choices bring the responsibility and problems of being a landlord. Where a section is big enough, subdivision may be possible, with surplus land to sell or, if funds available, to build a new unit or units for rent.

Finally, people may stay in their homes and borrow against the equity. A new mortgage may not be attractive (and may not be available to people over a certain age) as this means repayments of capital and interest, or interest only. But now there are “equity release” schemes, which present another option for older people.

Commercial Equity Release schemes

Many older people want to remain in their homes, where they have brought up their families, where they feel part of the community and which they own mortgage-free. But they are finding it difficult to make ends meet – to enjoy a comfortable retirement. In other words, they are “house-rich and income-poor”. These are the potential customer group for commercial equity release schemes. In New Zealand reverse mortgages are the main type of equity release schemes available (although there are variations in other countries).

A reverse mortgage is a loan is taken out against capital tied up in a house. No immediate repayments of capital or interest are required.  Interest accumulates on a compound basis and is added to the loan. Most schemes offer a “no negative equity guarantee”, which ensures that debt will never exceed the value of the property, even with the added interest. Usually, when the client dies or the property is sold, the full loan plus interest is repayable. Reverse mortgage schemes can provide lumps sums, regular income in the form of annuities, line-of–credit arrangements, or combinations of these. The line-of-credit option allows people to draw amounts of cash as and when needed (up to a set limit) and this reduces the amount of interest which is “rolled up.”

 

Rates Postponement

Some New Zealand local authorities offer Rates Postponement Schemes, aimed predominantly at ratepayers 65 and older, who can postpone their rates indefinitely if they choose. The accrued rates and charges are then paid back from the person’s estate when they die.

There has been much discussion of the pros and cons of equity release schemes. They are often seen as a “last resort” because the interest rates are high and the debt compounds rapidly, and because they limit choices about moving in later life. But it seems there is potential for safe, well-designed and innovative products in the equity release market to play a larger part in helping older people to release some of their capital to supplement their income in retirement, especially when they want to stay put. A lot depends on how acceptable this idea is to older people. They may not be keen to use up their equity if they are set on preserving it for their children’s inheritance.

 

Leaving something for the kids

How important is it to leave an inheritance for your children? What is inheritance for? In social and economic terms –

  • It formalises and symbolises family ‘lines’
  • It keeps significant or important property within a family
  • It is the final act of parents ‘providing’ for their children
  • It gives younger people assets to enhance their lifestyles.

The most common form of inheritance in New Zealand is for natural and adopted children to inherit equally from their parents. Commonly a surviving spouse inherits initially, and the property is handed on to the next generation when he/she dies. This pattern is enshrined in law in New Zealand. The Family Proceedings Act 1980 allows appeals against a will that does not provide for a surviving spouse or dependent children.

Given longer lives and later child-bearing, the ‘children’ inheriting may well be in their 60s or even early 70s. Inheritances may become a retirement lump sum. But if the older generation have used up their assets, then this won’t be possible.

 

Conclusion

To ensure a comfortable standard of living in retirement, older people need to manage their income and assets well. According to a ‘rational’ approach, people will draw down on their assets to supplement income in retirement, but this does not appear to be a widespread behaviour. In many cases, assets are unused and pass to succeeding generations as bequests, either intentionally or ‘accidentally.’

But in future, there may be a need for more active “decumulation” of assets in retirement. The pressures of an ageing population may mean NZS cannot be sustained in its present form. The full maturity of KiwiSaver is some way into the future and needs the development of suitable annuity and investment schemes if KiwiSaver lump sums are to support retirement incomes.

At the individual level, decumulation will help to fulfil aspirations for a high standard of living in retirement. It will help avoid the fear of ‘becoming a burden’ and improve the independence of older people. At the same time, assets that are consumed cannot then be bequeathed and this will have intergenerational effects. Much depends on the policy stance taken by governments to promote or require decumulation., But attitudes – to inheritance, to the management of money and financial risk, expectations of government, and responsibilities for care – will be equally, if not more, important.

The purpose of this article is to stimulate discussion around finances in retirement. It is not meant to be financial advice, nor should it be taken as such. We recommend you seek advice from a professional before making any major financial decisions.

By Judith Davey. First appeared on Age Concern New Zealand website.

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