By David Forsdyke, Head of Later Life Finance
Homeowners in retirement are being squeezed from all sides, including on their pension value. But for many, there is another option; property.
Nine in ten adults are reporting an increase in their living costs compared with a year ago and almost half are finding it difficult to stay on top of their energy bills, according to official figures.
Meanwhile, the FTSE 250 index has fallen by more than a quarter since the beginning of the year, putting pressure on investment portfolios and pensions. Many pensions already in payment are not likely to rise in line with inflation, meaning the true value of that income is being reduced.
Withdrawing funds during periods of volatility crystallises losses. Every £10 withdrawn this month would’ve been worth close to £14 just 10 months ago. Your remaining fund will have to work harder to recover the loss if you draw down now.
For many homeowners there is another option; property.
Rising house prices mean homeowners have gained an average £46,000 since the summer of 2020, according to the Equity Release Council. Lifetime Mortgages offer an opportunity for the more sophisticated retiree to utilise that equity while asset values are under pressure.
Lifetime Mortgages, the modern form of Equity Release, offer the option to borrow a small initial lump sum followed by access to a drawdown facility. This is a pre-agreed amount that can provide extra funds when required. Interest is only charged once funds have been drawn, meaning customers won’t be charged a penny if they never use it.
Borrowers can make frequent withdrawals, and they have flexibility to reduce or increase the amount they draw depending on their needs, or the bills that need paying. The interest rate applied to each withdrawal will be at whatever the lenders prevailing drawdown rate is at that time. This means that taking a drawdown facility now does not necessarily lock you in to a high interest rate. If rates do start to fall again, any future withdrawals will be at lower cost.
A practical example
Mr Jones is a higher rate tax payer who has been drawing £4,000 per month, or £48,000 per year, from his pension fund. Because of his tax status this actually costs him £80,000 per year from the fund.
He is concerned about recent falls in the value of his pension fund and wants to avoid crystallising any further losses. He’d prefer to leave his funds invested and allow markets to recover, so he has approached his financial adviser and our Later Life Finance experts to discuss the alternatives. His preference is to stop drawing from his pension for the next two years.
We have therefore recommended a lifetime mortgage with an initial lump sum of £10,000 and a facility of £86,000 which will allow him to draw the same £4,000 each month over the next two years. With interest compounding monthly this would result in a mortgage balance of £103,500 after 2 years*, which is significantly less than the £160,000 he would have drawn from his pension. If he then allows the mortgage to continue compounding it will reach £160,000 in approximately 9 years*.
When we presented this to Mr Jones he was keen to go ahead, as it allows him to stay invested in his pension fund. It also gives him and his financial adviser the flexibility to switch back to pension draw down within the 2 years should that become a more sensible option as markets change.
*Assumed Lifetime Mortgage interest rate 6.88% (MER), 7.1% (AER) fixed for life.
Please note, this person is fictional and the scenario is being used for illustrative purposes only, but is based on an actual client of Knight Frank Finance.
There are risks with borrowing against your property. The products are strictly regulated and cannot be sold directly. They can only be recommended by a suitably qualified adviser who will help you understand the risks before you decide to go ahead.