Equity Release

Funding a pension shortfall or meeting an unexpected expense

Rising incomes and savings pots among UK families are masking a widening gap between the ‘haves’ and ‘have nots’, an Aviva Family Finance Report reveals. Previously it has been seen that the typical family’s income reach its highest point since March 2012. Better savings habits also mean the typical family is saving a record £113 each month.

We all look forward to the day when we can stop or cut down on the amount of time we spend at work and all of the things we’d like to do once we’ve retired. If you’re facing a pension shortfall or need to meet an unexpected expense, equity release may be an option to consider. It allows you to unlock some of the wealth you’ve accumulated in your property without having to move. But before you consider taking this option, there are key aspects of it that you need to know.

The equity or value you have within your home is its open market value less any mortgage or other debt held against it. You are more likely to be able to make use of an equity release scheme if you have no current mortgage, or if any mortgage you have is relatively small.

There are two main types of equity release scheme:

Lifetime mortgage – a loan secured on your home, which is repaid by selling your home when you die or go into long-term care.

Home reversion – you sell all or part of your home to a scheme provider in return for regular income or a cash lump sum, or both, and continue to live in your home for as long as you wish.
With an equity release scheme, you:

  • Have to be over a certain age (usually over 55) and own your own home
  • Receive a tax-free cash lump sum, a regular income, or both, to use as you wish
  • Continue to live in your own home
  • Continue to be responsible for maintaining your home

Generating additional cash

When it comes to generating additional cash, some people may feel they have no option but to sell their home and downsize to obtain the money they need. With equity release, you can generate additional cash without incurring the cost and upheaval of moving.
If you do have an outstanding mortgage and want to take out equity release, you will need to settle your mortgage first, which will affect the amount you then have access to for other purposes.

Using the money released

Some people use the tax-free cash they receive from equity release to make improvements to their home, installing a new kitchen or bathroom, or just updating the property. Others may choose to help their families, whether it is helping children and grandchildren onto the housing ladder, helping with education, assisting in times of need, or simply allowing them to see their family enjoy their inheritance early.

The tax-free cash obtained from releasing equity can also be used to pay off existing debts, which can be one way of reducing your monthly outgoings, meaning that you could have more money available to live on.

Your equity release questions answered

Q: What happens to my partner if I die?
A: If the scheme is in both your names, the arrangements will continue.

If you are using equity release to improve your income, make sure you consider what the situation would be if you or your partner were to die.

If the property and scheme were in your sole name, the property would have to be sold and your partner would have to find somewhere else to live (unless, for example, they could repay the lifetime mortgage in full).

Q: Is there a minimum amount I have to take?
A: There may be a minimum amount you have to take. This, for example, could be £15,000 or £25,000. It will depend on the scheme and provider. But you may not have to take it all at once. Drawdown loans can be taken in smaller amounts over time.

Q: Would an equity release scheme reduce the amount of Inheritance Tax (IHT) due on my estate after my death?
A: An equity release scheme will reduce the value of the estate you leave when you die, so this may reduce a potential IHT liability. But if you are thinking of using an equity release scheme as part of your planning for IHT, you should obtain professional financial advice.

Q: Who would be responsible for maintenance costs in the home?
A: You will be responsible for keeping the home in good repair. If you don’t maintain the home, the scheme provider could arrange the necessary repairs and you would have to pay for them.

Q: Should I use equity release as a way of dealing with my debts?
A: Equity release may not be the best way to clear your debts. You should obtain professional financial advice to review your situation.

Q: Is a sale-and-rent-back scheme the same as a home reversion?
A: No. You may have to leave your home after the end of the fixed term in your tenancy agreement, which may only last five years. You will have to pay a much higher rent than under a home reversion plan, and the rent could go up.

Q: What happens if my partner or I need long-term care?
A: Your equity release scheme will usually carry on unchanged if care is provided in your own home or just one of you moves to a residential or nursing home. If you both move into a care home, the scheme will usually end and the property will be sold.

Q: What about changes in my circumstances?
A: If you take equity release while single and later decide to share the home, you may be able to transfer the scheme into your joint names, but this may only be possible if the second person meets the scheme’s minimum age requirements. There may also be a charge for this.

If you cannot transfer the scheme into joint names, the other person will not be able to stay in the home if you die or move out.

Releasing equity from your home is a lifetime commitment, so it’s worth including your family in any decision you make.

Equity release may involve a lifetime mortgage or a home reversion plan.

To understand the features and risks, obtain a personalised illustration from a professionally qualified adviser.

Equity release is not right for everyone.
It may affect your entitlement to state benefits and will reduce the value of your estate.

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Investments for children/Grandchildren

Defined Pension Schemes

If you are in your late 40’s to 50’s there is a good chance that you have worked for a Company that operated a Defined Benefit Scheme sometimes also known as a Final Salary Scheme.

Defined pension schemes pay their members a secure income for life which increases each year.

The pension income, if you are lucky to be a member of one of these types of schemes, is normally based on your pensionable service (the number of years you’ve been a member of the scheme), pensionable earnings (this may be your salary at retirement or an average over a set number of years) and the Accrual Rate (the proportion of your earnings you’ll get as a pension for each year in the scheme (commonly 1/60th or 1/80th)).

Unfortunately, as these schemes are incredibly expensive to administer they are being phased out by employers in favour of Defined Contribution Schemes.

Defined Contribution pensions work by building up a pension pot using your contributions and your employers (if applicable) plus the investment returns and tax relief. If you are a member of a scheme through your workplace, then your employer usually deducts your contribution from your salary before it is taxed.

For our children and grandchildren, this is the type of scheme that they will likely be enrolled in when they begin their working lives.

According to a recent Daily Express article sponsored by Key Retirement, 7 in 10 younger workers will experience a shortfall in their expected pension income because they are not saving enough.

Those around 30 years of age typically said they thought they’d need an income of around £23,000 for a comfortable retirement – this was based on a survey of 5,300 people.

However, when they looked at what would be the expected retirement income based on the amounts that people in this age bracket were saving it showed that they would be short by about £8,000 as the yearly income would typically be £15,000.

The report advised that if a 25-year-old wanted to achieve retirement income of £23,000 a year then they would have to look to start saving almost £300 each month into their pension.

Helping the Younger Generation and Pensions

As the younger generation may be struggling to save for their retirement due to Student Debts they may be paying back and saving for and buying their first home this is clearly a problem that must be addressed.

Perhaps for this generation, the help that we can offer with regards to their pension is minimal, with them perhaps looking towards money they’ll receive from their grandparents and/or parent’s estate to fund their retirement.

We can, however, help their children and although it seems like a strange idea to arrange a pension for someone who still might be in nappies the argument is compelling.  Parents or other family members can invest in a self-invested personal pension (SIPP) for a child, up to a maximum of £3,600 each year (£2,880 invested by you and 20% Government Tax relief).

Thanks to the tax breaks that come with saving in a pension, this means investing £2,880 annually -or £240 each month – with the balance being automatically reclaimed from the HM Revenues and Customs.

The benefit of compound growth over the long term is key so the sooner you start saving the better.

There is no minimum age for a junior SIPP, so it can be started the day that the child is born. The pension fund is outside the estate for inheritance tax purposes, so this could become a valuable exercise if you need to reduce your estate.

For the here and now everyday emergencies or situations that our children find themselves in, the Bank of Mum and Dad or increasingly Gran and Grandad never seem to close, charges an incredibly favourable interest rate and rarely call a debt in.

Saving for your child’s or grandchild’s pension whilst their retirement is a lifetime away may turn out to be one of the best investments you ever make for them.

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