Equity release has been long heralded as “the next big thing” by many who see it as a necessity to help bridge the pension gap but can equity release work alongside traditional pension planning?
Retirement Strategy asked Key Retirement Solutions group director Dean Mirfin and Axa Winterthur head of pensions Mike Morrison to discuss the feasibility of using a client’s property to help enhance a pension provision.
Mirfin says a property is many people’s biggest asset but pension planners are not discussing it and Morrison agrees that it is time to include equity release in the pension planning sphere. Mirfin says: “If someone is short of income, there has to be some space to look at property as an asset.”
Morrison says: “We are moving into an holistic market, where wraps and platforms mean people are looking at the overall assets and while the house does not fit onto the platform, it is an asset and it has to be part of the equation.”
But how can the schemes work together? Both experts agree there are two ways to use the proceeds of equity release – either invest a lump sum loan into the pension pot or use a lifetime mortgage withdrawal to supplement pension income.
Mirfin says: “The average pension pot is less than £30,000 but our average loan is just less than £40,000. Of course, that is not even the maximum you can raise from your property. Consider the size of an average home of a 40 per cent taxpayer at the point of vesting, who has lived in the property for decades. Using equity release could maybe quadruple his or her pension pot.”
The attraction of a lump-sum investment into a pension is the tax relief of up to 40 per cent. Mirfin says: “A lump sum plus 40 per cent, with the grossed-up 25 per cent cash is a great way to maximize your retirement finances. For example, if you have £100,000 gross, thanks to the addition of an equity-release lump sum, £25,000 is tax-free and can be taken out. With that you could pay off a chunk of the loan – doing it right could maximise your tax relief and reduce debt.”
Morrison argues that if using a pension tax-free lump sum is not suitable for the client, equity release could be used to provide a cash lump sum.
He says: “I can particularly see the benefits for this when it comes to a DB scheme. Quite often with DB final-salary schemes, the commutation rates means you are taking a part of your pension to take the cash and the commutation rates are not that generous and you give up more than what you are receiving.
“So why not forget the tax-free cash from your pension and, if you need cash, take the income from your home?”
Mirfin says holding off from spending the tax-free lump sum is key but not enough pension holders are being advised to do that. “Many of the people coming to us are two or three years into retirement because they have spent their tax-free cash,” he says.
Morrison says another benefit of using equity release is that you have the ability to keep yourself as a basic-rate taxpayer if you have a drawdown pension and use the tax-free lifetime mortgage as a supplement to income.
He says: “Perhaps you could use the equity release in the first year, your tax-free cash in your second year so the income you draw, which is taxable, you keep within the low band and supplement with lifetime mortgage income.”
If you want to retire, you have to sit down in your thirties and aim for it from there
Of course there are potential pitfalls. Morrison warns If you want to retire, you have to sit down in your thirties and aim for it from there
that there is the potential to be caught out by tax-free cash recycling rules.
He says: “There could be concerns with regard to tax-free cash recycling. It all depends on how closely HMRC looks at it but it has, in the past, looked at using tax-free lump sums to reduce mortgage payments as a means to increase pension contributions. There is a tenuous link to this with regard to using equity release alongside a pension but it is a minor concern.”
Both Morrison and Mirfin predict that the relationship between equity release and pensions will become more important due to the retail distribution review.
Morrison says: “I like the idea of an IFA retirement planner in the middle – he or she has the protection and pension advice over here, has the equity release lump sum over there. The central adviser also has the client’s stockbroker connected with a portfolio of equities. The IFA is in the middle, driving it all.”
Even though both see the potential of linking the benefits of equity release with a pension plan, neither Mirfin or Morrison see any benefit of trying to create a product that combines both sectors.
Mirfin says: “I don’t think it is about product, it is about advice. You have Aviva, Prudential, Just Retirement and LV= all doing equity release and they are doing pensions too but, even with both, where is the advice? The crucial link is the person, not the product.”
People are saving less and living longer and both agree it is inevitable that equity will become vital in helping people shore up their pension pot.
Morrison says: “If you want to retire, you have to sit down in your thirties and aim for it from there.”