Case Study - Do Your Sums Before Downsizing
A popular subject often talked about at family barbecues is; "should mum and dad downsize when they get older?" Often it's assumed that downsizing is the best option moving forward. To test and possibly challenge this we decided to run a few scenarios through our Pathfinder Financial Optimisation Platform to find out. Read our findings below;
1.1 The Clients
In this example, we look at the case of David and Alice who have recently retired and who will soonboth be eligible for the age pension. David was born on 11 April 1953 while Alice was born on 15 November 1952. They have a modest $400,000 in super. Their other assets are the family home valued at $900,000 and personal assets valued at $40,000. They have no debt. They would like to have $50,000pa (increasing at CPI) for living expenses. They are worried that their super is not sufficient to maintain their desired income. Consequently, they have contemplated selling the family home and moving to a cheaper area where they could buy a new home for $500,000. Will downsizing leave them better off?
We have assumed in the analysis:
- Pension fund returns 5.7%pa;
- House selling costs 2.5%;
- House purchase costs 6% (including stamp duty);
- House prices in the long term increase at 3%pa;
- CPI 2.5%p.a.
1.3 Scenario 1: Retain Current Home
We first examine the scenario where David and Alice retain their current home. In this case, they will receive income from the government pension as well as drawing a pension from their own super. Figure 1 shows the sources of their income over a 20 year period.
David and Alice receive approximately 64% of their income from the age pension and associated benefits (see also Figure 6 below). The remainder is withdrawn from their pension account through withdrawing the minimum amount each year (plus some extra for the first few years until they become eligible for the age pension).
Their age pensions are limited approximately equally by the income and assets tests. After 20 years, David and Alice have a combined wealth of $1,960,000 most of which is from the family home.
1.4 Scenario 2: Downsizing Family Home in 2016/17
The next scenario sees David and Alice downsizing their family home from $900,000 to $500,000 in 2016/17. Their ages enable them to deposit the excess funds generated from the house sale into super as non-concessional contributions. However, a Pathfinder® analysis shows that increasing their superannuation balance reduces their age pension because, unlike the family home, super counts towards the age pension assets test and is deemed for the income test. Figure 2 shows the results of the age pension assets and income tests for David and Alice and we can see that their pension is now limited by the assets test. For a home owning couple, the age pension reduces at a rate of $3 per fortnight for each $1,000 of assets in excess of $575,000. This taper rate was doubled from 1 January 2017, so now has a much larger impact on the pension received.
So in 2019/20, for example, their age pension reduces from $36,337 to $9,004 and they must draw more from their pension account to make up the difference. Their wealth after 20 years is now projected at $1,581,000 or about $379,000 less than in the first scenario.
1.5 Scenario 3: Downsizing Family Home in 2027/28
In the third scenario, we examine the possibility that David and Alice defer the downsizing for ten years, say in 2027/28. Their age pension is initially unaffected until they downsize the family home, but after that time their age pension payments are severely curtailed. Their projected wealth after 20 years is now $1,714,000. This is a better outcome than in the second scenario but is still $246,000 less than if they keep their existing home.
1.6 Comparing the Scenarios
Figure 3 gives a comparison of the annual age pension received in the three scenarios. You can see that the scenario where they retain their current home, yields a higher pension and that their pension drops sharply after the sale of their house in the other two scenarios.
Figure 4 shows the total age pension payments over the 20 years. You can see that by keeping their original family home, their total pension entitlement is significantly higher than either of the downsizing options we analysed.
Figure 5 shows the total wealth over the 20 year period analysed.
The first point to note is the importance of the age pension towards retirement income, depending, of course, on the particular circumstances. Figure 6 shows the composition of retirement income over the 20 years analysed for Scenario 1.
In this example, the age pension plus estimated concession card benefits contribute about 64% to income while the account based pensions contribute about 36%. The second point is that downsizing the family home may not result in improving the overall situation as an increase in payments from a private pension may be more or less offset by a decrease in the age pension.
1.8 Pathfinder Learnings
In our Pathfinder® analysis, we find, perhaps surprisingly, that a couple could be considerably worse off by downsizing the family home. Any funds added to super by the income generated from downsizing could be dissipated by a reduction in the age pension. In addition, the costs of sale and repurchase of a family home are significant.
The age pension can provide a buffer between retirement savings and lifestyle expenses.
For persons eligible for the age pension, downsizing the family home may leave you worse off financially because of the impact of the age pension income and assets test.