In the 2018-19 Federal Budget, the Government announced an expansion of the Pension Loans Scheme (PLS). Legislation has now passed through Parliament for the changes to come into effect on 1 July 2019.
The PLS, in its new format, allows qualifying Age Pension-age Australians who own property to take out a loan, irrespective of whether they qualify for an Age Pension payment.
The loan is in the form of a fortnightly payment from Centrelink up to 150% of the maximum Age Pension rate. For a single person, this loan potential is about $36,000 per year, and for a couple, about $54,000. Full or part pensioners will be able to borrow the difference between their current Age Pension and the maximum 150% rate.
For example, a single age pensioner eligible for the maximum rate of pension of around $24,000 will now be able to draw up to $12,000 more each year as a loan, bringing total cashflow (as a combination of Age Pension and Pension Loans Scheme) to $36,000 per year.
The loan takes the form of a reverse mortgage in that the interest and the loan do not have to be repaid until the house is sold, although it can be repaid earlier. The loan is at a compelling rate of 5.25%, which is less than commercial reverse mortgage interest rates (although the number of providers has fallen rapidly in recent years), and there are limits on how much can be borrowed based on age and the amount of home equity to be applied as security to the loan.
Key features of the PLS
Due to the way the PLS works, normal ways of thinking about a reverse mortgage do not apply. For example, eligible participants cannot withdraw a lump sum amount for an unexpected cost (as they can in a traditional reverse mortgage) because the amount is capped and trickles in through fortnightly payments.
Also, the Age Pension eligibility needs to be considered as it makes sense to run down savings to qualify for the maximum Age Pension before topping up with the PLS payments. For a single eligible Australian, the maximum asset level for a full pension is about $260,000, and for a couple it is about $390,000.
It’s all in the planning
The PLS will be become an important component in the planning of lifetime spending. Whether it is used or not, the fact that there is a potential source of cashflow that is supervised and administered by the government should provide some comfort to Australians in later life.
To understand how the PLS may fit in, it’s worth looking at the tools the government already provides for Australians in later life trying to work out how to manage their savings over time. The process needs to take into account investment earnings, Age Pension eligibility and the expected cost of living over a lifetime. The PLS should become a standard consideration in this process.
The Moneysmart Retirement Planner (MRP) is a government-sponsored tool that takes retirement savings and works out how much spending can be supported based on lifespan.
The ASFA Retirement Standard is the benchmark for the likely spending of Australians in later life. The result of a detailed study of the spending of older Australians, the ASFA Retirement Standard delivers an annual spending rate to deliver a ‘modest’ and ‘comfortable’ standard of living.
Put the two together and you get a starting number for how much is required for a comfortable retirement. The ASFA SuperGuru website suggests a couple will need $640,000 at retirement to spend at the ‘comfortable’ rate of $61,000 per year over a lifetime. Assets are run to zero by age 90.
The PLS adds a government-administered reverse mortgage component to this story. The couple who retire with $640,000 who were expected to limit spending to $61,000 per year, now have a little more flexibility with their cashflow over time.
For example, if they plan to spend $70,000 per year, would need to use the PLS at about age 78. Over the next 12 years, they would drawdown a total of $217,000, and the loan would be at $294,000 by the time they were 90 (taking into account interest and assuming they live that long).
They could also choose to use the PLS to supplement cashflow and maintain cash in the bank ready to address requirements as they arise. In the late years, the cost of aged care can be substantial and having funds at hand can offer comfort.
The Pension Loans Scheme and the ASFA Retirement Standard
The maximum rate of the PLS results in a cashflow almost exactly halfway between the ASFA ‘modest’ and ‘comfortable’ levels, as shown below. This provides a base case where homeowners with limited assets besides the home (subject to lending criteria) can secure a higher income.
|Max Age Pension||$23,597||$36,015|
|150% Max Age Pension||$35,396||$54,022|
What is the right mix?
The perfect mix will vary based on the requirements of older Australians. A couple may like a larger reserve pool to provide for future care. With the average aged care Refundable Accommodation Deposit of $424,000 in metro Sydney, there is good reason to do this. Similarly, a single age pensioner may like a substantial reserve to have comfort that home care costs can be met.
Spending planning is complicated but PLS helps
For Australians in later life, planning spending, and taking into account government support is enormously complicated. While simplified models like the MoneySmart Retirement Planner help guide decisions, allocating spending over a lifetime is complex, and the implications of mismanaging the drawdown of savings can be stressful at a vulnerable stage in life.
The Pension Loans Scheme is a useful lever to help Australians manage their reserves and cash flow in the later stages of retirement. Financial advice that includes a thorough understanding of the Australian entitlement system is vital.
Brendan Ryan is a financial adviser and Founder of Later Life Advice. This article is for general information purposes only and does not consider the circumstances of any investor.