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 the Office of National Statistics. Meanwhile, the FTSE 250 index is still 15% lower than it was a year ago, and volatility is increasing once again, putting pressure on investment portfolios and pensions.
Since the pension reforms of 2015, many retirees have preferred to draw funds down from their pension pot rather than purchase an annuity. However, withdrawing funds during periods of market decline and increased volatility crystallises losses. Every £10 withdrawn this month would’ve been worth close to £12 a year ago. This means remaining funds will have to work harder to recover the loss if you draw down now.
So what is the alternative?
Rising house prices mean homeowners have gained an average £46,000 since the summer of 2020*. For some, Lifetime Mortgages (a form of borrowing only available if you are over 55) provide a convenient way to tap into recent property growth while other assets are under pressure.
Lifetime Mortgages have become increasingly flexible in recent years, offering 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 you won’t be charged a penny if you never use it. You can also choose whether to pay interest on what you’ve borrowed each month or allow the interest to compound so there are no payments to make.
You can make frequent withdrawals, and you have flexibility to reduce or increase the amount you draw depending on your needs. 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.
How does it work? A case study
Mr Jones is a higher rate taxpayer 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 if he can, thereby preserving a potentially higher pension fund for his future.
A lifetime mortgage with an initial lump sum of £10,000 and a facility of £86,000 will allow him to draw the same £4,000 each month over the next two years. If he lets the interest compound monthly, this will result in a mortgage balance of £102,250 after 2 years**, which is significantly less than the £160,000 he would have drawn from his pension. If he then stops drawing down and allows the mortgage to continue compounding it will reach £160,000 in approximately 11 years**.
When we presented this to Mr Jones and his financial adviser they were keen to go ahead, as it allows the pension funds to stay invested over the next 2 years. 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.
Is it right for me?
There are obvious risks with borrowing against property, and the scenario above will not be appropriate for everyone. 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 and the benefits before you decide to go ahead. Our team of experts will work closely with you and your pension adviser, looking at your specific situation and only recommending a lifetime mortgage if it is suitable.
If you would like to know more about lifetime mortgages or to discuss your borrowing requirements, get in touch with our Later Life Finance team. Our advisers are experts in their field and can help you navigate the market.
*According to the Equity Release Council
**Assumed Lifetime Mortgage interest rate 5.94%
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.