Inter-Generational Financial Planning and the Family Home
As the name suggests, intergenerational financial planning (‘IFP’) aims to treat a family as what it usually really is – a single vertically-integrated economic unit. Most people think across the generations when it comes to their wealth management – and so advisers should too.
This is particularly the case when it comes to homes. Homes account for 43% of Australian household wealth. What’s more, around 70% of Australians live in a home they own themselves (with or without a mortgage). Put simply, homes are critical to the financial aspirations of most people.
We see all of our clients as potential candidates for IFP. We always spend a little extra time with all of our clients, during which we find out a bit more about the person, their life views and their relationships with friends and family. The purpose is not completely social. Often the extra time reveals important facts, hopes and attitudes that can then be blended into our advice and strategies, making them better than ever.
This ebook discusses one of the critical elements in IFP: housing and how best to manage it. Given the current crisis in housing affordability, we think this is a great time to discuss how family homes should be managed when thinking about the transfer of wealth across the generations.
We explore three particular aspects of the family home – how to manage it upon retirement, how to help other adults (be they your adult children or your parents) purchase their own and how to manage a home upon entry into the aged care system
The Family Home and Retirement Planning
One of the key benefits of a family home is that its value is exempt from calculations used to determine Centrelink aged pension benefits. In addition, if and when an owner needs to move into an aged care facility, only a portion of the family home is counted in the assets test used to calculate the means-tested components of the accommodation and care costs.
This is often a good reason for older people to retain the family home, even beyond the point when they move into aged care.
In December 2014, the Grattan Institute published ‘The Wealth of Generations.’ The research paper can be viewed here. The report contains some very significant findings, including the observation that the wealth of Australians aged between 65 and 74 increased by an average of $200,000 in the eight years to 2014. The wealth of Australians aged between 25 and 34 decreased on average over the same period. This increase was entirely due to the fact that older Australians were more likely to own homes, and more likely to own those homes outright, then their younger counterparts.
Amongst other things, this tells us that there is about to be a very significant transfer of wealth from older Australians to their younger children and grandchildren.
Inheritances upon death – estate planning and the family home.
The first thing to note is that not all family homes are included in a deceased’s estate. The entity that is ‘the family’ is not a legal person. Therefore, ‘the family’ cannot own an asset. Instead, individual members of a family own the home under some form of co-ownership. By far the most common such form is ‘joint tenancy.’ Joint tenancy is subject to the principle of survivorship, whereby the remaining joint tenants automatically acquire a deceased person’s share of a property upon death. There is nothing left to the estate of the deceased. It is only when there is one surviving owner, at which point the property ceases to be a joint tenancy, that estate planning for the property becomes an issue.
Where a couple own a home as joint tenants, the home will eventually form part of the estate of the second member of the couple to die. This means that most wills for home-owning couples will still contemplate the family home as an asset, if only in the event that the willmaker is predeceased by their partner.
The main alternative to joint tenancy is for two or more people to own a home as tenants in common.
Capital Gains Tax
Provided that the home was the principal place of residence for deceased person, there is no CGT payable upon the transfer of a property following death. This is the case whether title to the property is transferred to the deceased’s beneficiaries or is sold to a third party.
If a person moves out of a property, the principal place of residence exemption extends either indefinitely or for 6 years after a person vacates a property, provided that they do not claim any other property as the principal place of residence during that period. If a person vacates a property and rents it out, they can continue to claim the exemption for six years. If a person moves out of a property and does not rent it out, (perhaps allowing family or friends to live in it rent-free while the owner lives elsewhere) the CGT exemption remains indefinitely – provided again that only one property can be claimed as the principal place of residence at any time. This second case can be especially significant if the property owner is elderly and needs to live in the care of relatives or friends.
Targeting the Inheritance
Sometimes, clients will seek to target particular assets to particular beneficiaries in their will. A common example is where there is an adult child who is disabled and continues to live with their parents into adulthood. In these cases, many parents leave the home to that child, and leave other assets (such as investment assets) to their other beneficiaries.
What to do with the Inheritance?
Once a home has become the subject of a will, ultimately it can be either sold or kept. If kept, it can be used either as a place for one or more of the beneficiaries to live. Alternatively, it can be held as an investment. If it is lived in by a beneficiary, then it may become their principal place of residence, in which case it will retain its CGT exempt status into the future.
If the family home is a representative residential property (by which we mean it is likely to achieve the average rate of return for residential property) then retaining it as an investment is often a good financial move. The twenty-year average return on residential Australian property to 31 December 2015 was 10.5%. This return slightly exceeded that for Australian equities over the same period.
Whether a home is kept often depends on the number of beneficiaries who are to share it. As would be expected, where multiple beneficiaries are entitled to a share of the property, it is typically harder to keep the property. The beneficiaries would need to agree to become co-owners, which would in turn require that they each have similar personal financial situations.
Keeping the home is more common where there are fewer beneficiaries. If there is only one beneficiary, then he or she simply makes up their own mind as to whether to keep the property. Where there a few beneficiaries, they may decide to own the property as co-owners. Or, one common alternative is for one beneficiary to ‘buy out’ one or more of the other beneficiaries. This is discussed in this article by Di Rosa Lawyers, in Adelaide.
Timing the Inheritance
Most inheritances are received relatively late in the recipient’s life. The report by the Grattan Institute includes the following graphs:
What the graphs show is that a person’s prospects of receiving an inheritance peak in that person’s 50s and 60s. What’s more, if the inheritance is delayed until later in life, it is larger. That is, the relatively few younger people who receive an inheritance receive smaller inheritances. This is simply because most people inherit from their parents. This happens relatively late in the inheritors’ life as their parents live into their 80s and 90s.
Assisting Younger Generations to Buy a Family Home (or a Better Family Home)
As the above graph makes clear, most inheritances occur after the recipient turns 48. By that age, the recipient is already well into their own peak cost years – the years when they are raising children. The following graph comes from the University of Canberra’s National Centre for Social and economic Modelling’s (NATSEM) 2013 report, ‘The Cost of Raising Children in Australia.’
As the graph shows, the proportion of household income that is spent on children is high throughout their life, peaking once they turn 18. Unfortunately, inheritances, when they come at all, usually come after the kids have been raised.
How handy would an inheritance be if it was received earlier in the recipient’s life – when they most need it, but before their benefactor actually dies?
For this reason, increasingly, older clients are looking for ways to assist adult children to buy their own home while the older client is still on the planet. Ways to do this include:
- Buying a home in conjunction with a child;
- Guaranteeing a loan to assist a child to buy his or her own home;
- Utilising interest offset accounts such that the older client’s savings can offset the younger person’s mortgage;
- The older client gifting some money to the adult child; or
- The older client making a soft loan to the adult child.
We discuss each of these in the next section
Buying a home in conjunction with a child
Some young clients buy homes as co-owners with their parents. Their parents usually provide 100% of the deposit, guarantee the loan and generally make the project work.
This strategy has worked for some clients, but it is not for everybody. The reason is simple: the client ends up only owning half a home. For some people, half a home is better than no home. For others, half a home is less than they want and less than they need.
But at least this strategy has them on the path to wealth.
The strategy can work best where the adult child is an only child (or, if there are siblings, the parent co-owns similar properties with all of them). In this case, owning the property as joint tenants can be a good idea. Under a joint tenancy, when one owner dies, their interest in the property simply passes to the other owners. Where the two owners are parent and child, the usual expectation is that the parent will die first. If that happened, the child automatically comes to own the rest of the property.
The alternative is to own the property as tenants in common. In a tenancy in common, the ownership interests are separate and can be sold to third parties (subject to any co-owner’s agreement) or bequeathed to third parties under a will.
Your decision as to which method to use will depend on your specific circumstances. Advice as to whether to own a property as joint tenants or tenants in common is actually legal advice. Through our relationship with MLA Lawyers, we can provide a low-cost way for you to ensure that you get your co-ownership arrangements right.
Guaranteeing a loan
Anecdotally, more than two thirds of first homes are bought with significant parental assistance, usually in the form of deposit gifts, repayment subsidies, extra security and guarantees.
Of these, often the best form of assistance is a parental guarantee. You can read more about parental guarantees on the St George Bank website, here
Done prudently, normally there is little risk with a client’s parent providing a guarantee. Think about it: the parent is only exposed to the possible drop in value of the property. History suggests that this is probably not a great amount. Once a few years have passed the risk usually disappears, as the property increases in value and the equity builds. And if a client is facing a default on their loan, they can always try to earn a bit more by working weekends or nights if they have to.
(In extreme cases, the parent might even do this themselves).
We think parental loan guarantees for young clients often make a lot of sense. They mean the young client can buy more house, sooner, and this usually means more capital gain for less effort. Realistically there is not much risk for the parent.
Common sense is needed but within limits parental guarantees are an idea that should be contemplated whenever a younger person is looking to buy a home.
Interest offset accounts
Many lenders will allow clients to have one or more savings accounts that are matched to a home loan and offset the amount owed on that loan. The effect of this is that the amount of interest charged is reduced. Some lenders will even allow more than one savings account to offset the loan. Here is how Bankwest explain the effect of $5,000 held in an offset savings account linked to a loan of $300,000.
Where an adult child has a mortgage, and there is a scope for there to be more than one offset account, it can be a good idea for the adult child’s parents to use one of these savings accounts as their own bank account. This allows their adult children to enjoy the benefits of offsetting the interest on their home loan, while the parents (who have access rights to the account) still control their money.
The interest saved on the home loan will always be more than the parents will receive if the cash is held in a savings account in their own name. For example, the children might be paying (a non-deductible) 5% on their home loan while the parents only receive 1% (potentially taxable) on their savings. This means that the family is much better off if the parents’ money is used to offset the child’s mortgage account.
Some families even ask the child to pay the parents the lower interest rate on the savings (that is, what the parents were going to get). This is still a win, as the child is avoiding a much higher interest rate, and the parents do not lose.
Typically, the savings account offsetting the mortgage needs to be in the same name as the mortgage account. This means that money being used in this way is, prima facie, the legal property of the mortgage loan holder (that is, the child). For this reason, this form of arrangement should be coupled with an agreement between the parents and their child (and the child’s partner if there is one) such that the legal right to the cash in the account is passed back to the parent. A simple way to do this may be for the child to declare that the amount in the account is being held on trust for his or her parents.
This declaration should occur in some form of legal agreement. We can assist you to obtain quality legal advice at a very competitive price if you need assistance here.
One more thing to note: parents who ‘give’ their children money to use in an offset account will be deemed to still have that money for Centrelink purposes.
Gifts or soft loans
Many parents simply give their adult children cash gifts, either as a lump sum at the start of the home purchase to help with the deposit or regularly over the life of the loan. These parents need to remember that the gift means that the money becomes their child’s property. If their child is in a relationship, then the money can actually become part of the property of the relationship. If the gift is for a large amount and/or there is a risk of a relationship going ‘sour,’ then legal advice should be sought.
‘Soft’ loans are loans that only need to be repaid in certain circumstances (such as if and when the adult child sells the home being purchased). Once again, they can be a good way to help with the deposit and to ease the non-deductible debt burden. The fact that the money is a loan means that it does not become the property of the younger person and thus it will usually not become part of the relationship assets in the event of a relationship ending. Obviously, these loans need to be property documented as loans and can even be secured with mortgages to give maximum asset protection if a family law or bankruptcy event occurs.
Assisting Older Generations to Buy a Family Home (or a Better Family Home)
Sometimes, it is the younger generation that is in a position to help the older generations buy homes. This is often the case where the older generations were the original immigrants to Australia, for example, and arrived with limited employment prospects. The children of immigrants have long been over-represented among the ranks of academic achievers, and this correlates with higher earnings for those children.
In these situations, many of the techniques commonly associated with older clients helping their children can simply be reversed. A younger client might co-own a home with his or her parents, for example. Or, a young person might use their savings to offset a mortgage for their parents.
For higher tax-paying younger clients, the tax advantaged nature of the family home can be of assistance. If the home is wholly-owned by their older relative, with the younger client then to inherit it when their parent or grandparent dies, then there will be no capital gains tax payable when this happens. (Against that is the obvious fact that interest on any money borrowed to finance the purchase is not deductible along the way).
The Importance of Written Agreements
While most people consider their family to be a single economic unit, the law does not. For that reason, transfers of wealth between generations should usually be supported by written agreements between the participants. This can often be overlooked.
For example, if a client gives money to another person to be used towards buying a home, then that money becomes the property of that other person. If this other person is married, for example, then the money actually becomes part of the assets of the marriage – and can be distributed accordingly if the marriage ends.
Superannuation and Family Homes
Very commonly, the main focus of IFP is to provide housing for the younger generations – at least, housing that is within a sensible distance of where Grandma and Grandpa are living.
Accordingly, it pays to remember that, ultimately, private housing must be bought using after-tax dollars. The deposit used to purchase a private residence, for example, must be saved after tax is paid on the purchaser’s income. The principal and interest payments on the loan must also be paid out of after-tax income. Ultimately, the whole property is paid for after-tax.
As a result, it becomes clear that, where the tax payable on income is lower, it will require less pre-tax income to buy the same amount of house. The following table shows how much pre-tax income is required to buy a $500,000 property for various marginal tax rates.
|Tax Rate||Pre-Tax Amount Required||Tax Paid||Amount Remaining|
The second column shows the pre-tax cost of a $500,000 property. The 15% tax rate is that rate payable on deductible super contributions into a super fund. The point of the table is this: if families make deductible super contributions into someone’s super fund, and then withdraw these contributions tax-free when the relevant person reaches the required age and use the money to purchase housing, the family only needed to earn $588,000 pre-tax to buy a $500,000 property. If the relevant part of the family instead pays tax on income at 45%, and then uses what’s left to purchase the property, the $500,000 property costs over $900,000 in terms of what must be earned to buy the home.
Judicious use of super can reduce the time taken to earn enough to buy a property by more than a third.
Because of this, wherever a property needs to be purchased somewhere within a family structure, it pays to think about whether the tax advantages of super can be realised.
Tim and Jobe
Here is an example of how this might work. Tim is in his early sixties. He became a dad at 35 and his son Jobe is graduating from Uni at the age of 27. Jobe wants to save $40,000 over the next three years for use as a home deposit.
Tim’s adviser Noni has a good idea. Tim earns $80,000 a year as a senior administrator. Noni suggests that Tim sacrifice an extra $20,000 in salary as a deductible super contribution each year for the next three years. Given his tax rate, this only costs him $13,500 in lost purchasing power each year. He replaces this lost purchasing power by asking Jobe to pay board of $1,100 per month – the money he was intending to save for his deposit.
Within his super fund, Tim accumulates an extra $17,000 each year, after tax. If this is held in a conservative investment (akin to the term deposit), he can expect to have around $52,000 in three years’ time. Having reached the age of 65, he can withdraw this amount tax-free and use it as he sees fit – basically, his first order of business upon retirement is to help his son get started financially. Tim can give Jobe almost $10,000 more than he would have if he saved the money in his own name.
The family home is a special case in retirement and aged care planning.
Often, we take a different view of the family home than many financial advisers. Basically, we recognise family homes as the cornerstone of most people’s wealth. So, our starting point is that the family home should usually be retained whenever possible.
That said, no two clients are the same. Each situation needs to be taken on its merits. The following sections discuss the interplay of the family home and aged care planning and talk to general themes that need to be addressed when you are planning for aged care.
There are many potential benefits of retaining a family home when moving into residential aged care. These include:
- Reducing your asset base for calculating the means tested care fee payable;
- Retaining an asset from an asset class that has traditionally done as well or better than any other asset class;
- Retaining the ability to borrow against the home;
- Retaining the ability to derive rent from the home;
- Retaining exposure to capital growth in cases of relatively long stays in residential care;
- Retaining wealth in a CGT-free investment type;
- The personal wellbeing benefits from knowing that the family home has been retained; and
- Potential compatibility with your inheritors’ plans.
There are also potential benefits of selling a family home when moving into aged care. These include:
- Being able to pay cash for the Refundable Accommodation Deposit (‘RAD’) required by most homeowners when entering an aged care facility;
- Achieving an effective rate of return of 5.7% when paying the RAD as a lump sum;
- Avoiding the need for complicated financial management, such as the use of reverse mortgages or the management of a tenancy;
- Freeing up cash flow to be used for other lifestyle choices, such as paying for extras in the aged care facility; and
Simplifying affairs, especially in cases where there are multiple people affected by your decision.
In determining what to do with your family home, there are a number of particular factors that should influence the decision. These are discussed in the following sections.
The Home is usually the Major Asset
For many, if not most, people, the family home is typically the major asset that they own. In cases where a person has retired with substantial super or other non-home wealth, these benefits have often been drawn down by the time an aged care facility looms.
For example, according to the Australian Institute of Health and Wellbeing, only 8.7% of residents of aged care facilities are self-funded retirees. The overwhelming majority claim either a DVA or a Centrelink pension. This tells us that they have relatively few assets outside the family home (the family home is exempt from the assets test for these benefits).
Accordingly, the decision regarding the family home will often be the most significant decision that you are likely to make (or have made on your behalf).
Residents contemplating residential aged care are necessarily frail. Accordingly, it is common for at least one other person to be involved in a resident’s financial management.
Often, this goes well. But the reliance on someone else can raise issues to do with propriety. Put simply, it is not uncommon for an older person’s children or grandchildren to start to see their parent or grandparent’s family home as their own once their older relative enters an aged care facility.
Interestingly, the Office of the Public Advocate in South Australia has seen fit to remind people that they simply do not have a right to an inheritance while their loved one is still living.
For us as advisers, the older person’s reliance on someone else can raise some ethical issues. As professionals, we must put our client’s best interests first. However, the ‘best interests’ of the elderly client are not necessarily the same as the ‘best interests’ of the eventual beneficiaries of the clients’ estate.
The law, and our own ethics, require us to always act in the best interests of our client – and no one else. If you are an older person, you can be sure that our advice to you will always represent our opinion about what is the best thing for you to do.
Powers of Attorney and Trustees
Ideally, where frailty has become an issue, an older person will have granted one or more powers of attorney to some other person to act on their behalf. This will include making decisions regarding the family home. The power of attorney legally empowers the other person to make decisions on behalf of the older person.
The key thing for the attorney to remember is that they have a fiduciary duty to act in the best interests of the older person. This means that the older person’s interests must take precedence over any other person’s interests.
The Length of Stay in an Aged Care Facility
One of the most difficult factors in deciding whether to retain a family home is the fact that the length of stay in an aged care facility is unpredictable.
According to the Australian Institute of Health and Wellbeing, the average length of stay in an aged are facility, as of 2011, was around 145 weeks, or just short of three years. Stays were shorter than this for men and longer for women (and 70% of residents are women).
145 weeks is simply an average. There is substantial variation around that number. 27.1% of people stayed for less than two years, while 20.5% of residents stayed for more than five years (this figure was slightly higher in major cities).
So, relatively long stays in aged care facilities are common: 1 in 5 people who enter residential aged care will still be there 5 years later. The system takes this fact into account in various ways. One is the lifetime cap on the means tested care fee payable by residents. This fee is capped at around $62,000 (this figure does increase with inflation) for life. Another is the fact that the Refundable Accommodation Deposit does not increase once a resident has moved into a facility.
Residents using debt, such as a reverse mortgage, to pay some or all of a DAP may find that the amount of debt starts to approach the limits on the debt as the years pass. Simple investment analysis tells us that the net equity in the home should not be affected, as long as the growth rate on the home keeps track with long-term averages. But growth can be lumpy, and so a plan for what happens if the debt starts to approach its limit makes sense.
The best plan, of course, is to minimise the amount borrowed wherever possible.
The presence of a ‘protected person’
A protected person is someone whose continued presence in a home after the owner (or co-owner) moves into residential care has the effect of exempting the home from the assets tests that apply to aged care. There are four categories of protected person. These are:
- The resident’s spouse or partner;
- A dependent child or student;
- A residential carer of at least two years standing and who is entitled to a Centrelink benefit on the day the resident moves into the aged care facility; or
- A close relative who has lived with the resident for at least five years and who is entitled to a Centrelink benefit on the day the resident moves into the aged care facility.
The presence of a protected person means that the value of the family home is not counted towards the assets test for either the means tested care fee or the accommodation fees.
In most cases, then, where a protected person remains in the family home, there is an economic rationale for keeping the family home. Which is kind of nice, because the protected person still needs somewhere to live!
The absence of a protected person.
Where there is no protected person, the decision as to whether to keep the family home becomes just that: a decision. The client and their adviser need then to decide whether and how to keep or dispose of the family home.
Capital Gains Tax
One issue that is usually worth keeping in mind is that the principal place of residence exemption that applies to a family home continues for up to six years after a person leaves the home, as long as they do not claim another principal place of residence. (the extension is indefinite if the home is not rented out).
In addition, where a principal place of residence forms part of a deceased estate, then there is a two year period following the death of the owner during which the CGT exemption continues to apply.
What this means is that the CGT-free status of a family home can continue for up to six years following the owner’s entry into an aged care facility.
Alternative uses of the proceeds of any sale of the family home need to be weighed against this feature of the family home.
There are three types of fee that will definitely be levied on home-owning residents of aged care facilities, and a fourth that probably will. The three ‘definites’ are: the accommodation fee, the basic daily care fee and the means tested daily care fee. Of these three definites, the basic daily care fee will not vary depending on the decision made regarding the family home. This leaves two definite expenses that will be affected.
The ‘probable’ fee is the additional ‘extra care’ fee that may be charged by the facility for additional things such as recreation.
In the section that follows, we restrict the analysis to the two definite fees that are affected by your decision as to what to do with the family home.
Means Tested Daily Care Fee
The means tested daily care fee includes the family home among assets used for the assets test for this fee, but only to a limit of around $162,000 (current figures – this does increase with inflation) and only if there is no ‘protected person’ living in it. As a starting proposition, this preferential treatment for the family home often creates a financial incentive to keep the family home.
The reason for this is simple: while the family home continues to be held, no more than $162,000 of its value counts towards the assets test. Once the home is sold, the proceeds of the sale of the family home count in full towards the assets test. Presuming the family home is worth more than $162,000 this increases the relevant asset base. So, keeping the family home generally leads to a lower means tested care fee.
There are some situations where the means tested daily care fee will not be affected by the decision regarding the family home. These situations include where the value of other assets is so high, and/or the size of the resident’s income is so high, that the maximum means tested daily care fee will be payable anyway. In those cases, the impact on the means tested daily care fee of selling or keeping the family home can be ignored. The decision can be made on other grounds.
The specific impact of the decision on keeping or retaining the family home will vary according to the specific situation in which a client finds him or herself.
While a decision as to whether to sell or keep the family home will impact on the means tested care fee, the effect is probably quite marginal. It is in deciding how to pay the accommodation costs that the decision about the family home becomes more fundamental.
Accommodation Costs – Deposit or Daily Payment?
Accommodation costs will almost certainly be payable by anyone who owns a home. This is because the upper threshold for these costs is around $162,000 (again, indexed to inflation). This threshold includes the family home, and very few homes are worth less than this. So, most people with a home will exceed the threshold.
There are two ways to pay the accommodation costs. The first is to pay a Refundable Accommodation Deposit (RAD). This is the whole cost of accommodation and is negotiated with the aged care provider. The provider is obliged to advertise the maximum RAD payable on an available room. There is often scope for residents to negotiate a fee that is actually lower than this – especially in a facility with vacancies.
The second is to make a Daily Accommodation Payment (DAP). This payment, expressed on a daily basis but in practice paid on a monthly or quarterly basis, is calculated as a percentage of the RAD. The maximum percentage is currently 5.7%. Thus, the daily amount is 5.7% divided by 365 multiplied by the RAD.
For example, if the negotiated RAD is $400,000, the RAD is $62.44 per day.
A Critical Figure – The Maximum Permissible Interest Rate
Financially, the critical figure in deciding what to do with the family home is really the maximum permissible interest rate. As of October 2017, this rate is 5.70%. A resident moving in to an aged care facility must pay either a one-off RAD or a daily payment equal to an annual 5.7% of the RAD.
These paragraphs assume that the maximum permissible interest rate is being charged. If a lower rate applies for the particular aged care facility, then that is the rate that is critical to the financial decisions.
When it comes to the RAD, if a resident can achieve a rate of return greater than 6.14% via some other investment, they are better off making that investment instead of paying the RAD. They would then pay their accommodation expenses as a DAP rather than as a lump sum. If they cannot achieve a rate of return that exceeds 5.7%, then they are better off paying their accommodation expenses as a RAD. The RAD gives them the superior rate of return.
To give a simple example: a resident with $100,000 in a cash management account earning 2.4% would be better off withdrawing the cash and using it to pay the deposit. The cash management account is earning (roughly) $6.75 per day, being the $2,400 annual interest divided by 365. Using the $100,000 to pay a lump sum towards accommodation saves $15.60 per day, being 5.7% of the $100,000 divided by 365.
As (effectively) a guaranteed rate of return, 5.7% is hard to beat. Therefore, where there are assets outside of the family home, these assets should typically be used to pay the refundable accommodation deposit. This saves the resident 5.7%.
However, the rate of return on residential property has long exceeded 5.7%. So, keeping the home and paying the 5.7% makes good sense. So, as a starting point it can be said that retaining the family home is likely to be a good option where possible. This is particularly the case where the RAD is less than the value of the family home. (This assumes, of course, that the family home is a representative one).
Paying a RAD While Keeping the Family Home
For some people, keeping the family home and paying a RAD are not mutually exclusive. A RAD can be paid in various ways. These ways include:
Borrowing a lump sum against the family home, or some other security. Some residents may simply be able to borrow an amount to pay the RAD. If the rate of borrowing on any such loan is less than the effective interest rate used for a DAP, then this will work well. For example, if the DAP is 5.9% and the interest paid on a loan is 4.9%, there is a 1% arbitrage available. If a client borrows $100,000 to pay all or part of a RAD, they will pay interest on the loan of $4,900. But they will negate DAPs of $5,900 per year. They are $1,000 better off.
Care should be taken here to first ascertain what interest rate is being applied by the aged care facility. As its name suggests, the maximum permissible interest rate is the upper limit of what can be charged. Some facilities may charge a lower rate.
The most common way to borrow for a RAD is to use some form of reverse mortgage. Clients may also borrow from other sources. For example, a client may borrow the money from an adult child or grandchild. The child or grandchild may even finance the RAD themselves by borrowing at some cost lower than the MPIR.
One thing to be aware of here: any amount paid as a RAD on behalf of a resident will count as an asset when that person is means tested. This asset can be offset if the amount is properly cast as a loan, as there will be an offsetting debt. A formal loan agreement is therefore a good idea in such a case.
Such an agreement also ensures that the money used for the DAP does not become a gift to the resident, which may then see it included as an asset under that person’s will.
Using other assets to pay the RAD. The effective rate of return on money used to pay the RAD is currently 5.7%. This is ‘guaranteed’ in the sense that it negates a known cost: if you pay the deposit, you are guaranteed to avoid the cost. This is a higher rate of return than most residents will be able to achieve on any cash or cash-like investments. So, a client with cash should generally use that cash to pay some or all of their RAD.
To give a simple example: a resident with $20,000 in cash will receive no more than 1% or so (if that) as interest on that amount. That is $200. If they use that money to pay some of a RAD, they will reduce their DAP’s by $1,140 per year.
Having someone else pay the RAD. A similar logic to that which applies to using other assets to pay the RAD can apply where there are other people involved with the resident. For this discussion, we will assume that the resident has a ‘child’ who may be able to pay some or all of a RAD. (That ‘child’ is likely to be in or over their fifties, but we will call them a child regardless).
That child, for example, may have some cash that is being held in a cash or cash equivalent account. The interest being received will almost certainly be less than the 5.7% that could be obtained by making a RAD. Using the money to instead pay all or part of the RAD will maximise the family’s financial position, because the resident’s costs will be reduced by more than the revenue given up by their child.
It could even be the case where the child charges the parent an interest rate that is the same or more than what the bank would pay, but that is less than 5.7%. For example, if cash was earning 2% in the bank, the child could use it to pay the DAP and ask the resident to pay them 2% to compensate for the lost interest. The child is in the same situation, but because 2% is less than 5.7%, the parent is still better off.
Once again, something to be aware of is that any amount paid as a RAD on behalf of a resident will count as an asset when that resident is means tested. This asset can be offset if the amount is properly cast as a loan, as there will be an offsetting debt. A formal loan agreement is therefore a good idea in such a case.
Such an agreement also ensures that the money used for the DAP does not become a gift to the resident, which may then see it included as an asset under that person’s will. Where there are other beneficiaries under a will, for example other siblings, this inclusion could be a problem. A loan agreement will avoid that problem.
Ways to Pay a DAP when the Family Home is Kept
The alternative to paying a RAD is to pay a DAP, calculated by applying an interest rate (currently usually 5.7% – October 2017) to the RAD that would be payable.
This alternative requires the resident to be able to access either a lump sum to pay the RAD or cash flow equal to 5.7% of the RAD each year.
As we have said elsewhere, there is little point in keeping a cash ‘float’ to be used to pay a DAP. This is because the cash would earn an effective 5.7% if it was used to pay at least part of the RAD. So, this analysis assumes that the resident needs to obtain cash flow from some regular source to finance the DAP. There are three broad options.
Rent the family home to a tenant. The tenant may or may not be related to the resident. The average yield for a rental property in an Australian city is 3.5%. Allowing 0.5% of these receipts as costs, this leaves about 3% available for the property owner. On its own, this will not be enough to pay the standard DAP in cases where the RAD is the same as, or close to, the value of the property.
If the RAD is less than half of the value of the property, then the rent received should cover most, if not all, of the DAP. Similarly, if the yield on a particular property is higher than the average, then the ability to pay a DAP is increased.
Please note that rent received by renting the family home may have a negative effect on any aged pension that the client is receiving. The aged pension is subject to an income test. In addition, the rental income will also count as income in the income test for the means tested daily care fee test (this change took effect from 1 January 2016). If the rent exceeds the income threshold for the means tested care fee, then 50% of the excess amount will be counted toward this fee. However, this fee is also subject to an annual and a lifetime cap, such that the ‘cost’ of earning rent, in terms of increased means tested care fees, is limited to no more than these caps.
Borrow Against the Home. The second option is to borrow against the home (or some other asset, including assets owned by another person, such as a child’s home). This is essentially a reverse mortgage, although often a better rate of interest can be obtained by taking a simple line of credit loan secured against the property. The borrowing against the property can be kept to no more than 5.7% of the value of the RAD.
Basically, the resident or their representative organises for a periodic direct debit to the aged care facility from the loan account.
Of course, this option can also be used in conjunction with the option to rent the family home. The property may be able to be simultaneously rented and borrowed against.
Use Cash Flow Derived From Elsewhere. A third alternative is to use cash flow derived from elsewhere. This may mean income derived from other assets, such as investment properties or shares. As stated elsewhere, typically it will not include income derived from cash or cash-like investments such as term deposits, because the resident could obtain a better effective return by using that cash to pay some or all of their RAD. But if income from other sources is sufficient, then using this income to pay the DAP can be a good move.
Remember, paying the accommodation expenses as a DAP is tantamount to borrowing at the relevant interest rate (currently 5.7%). This means that it can make sense to retain other assets that can be expected to grow at a rate greater than this. As a long-term proposition, and on average, such assets have historically included residential property and Australian shares.
An alternative source of cash flow might also include other generations within the family. These people may wish to retain the family home for personal or investment use, and could thereby agree to provide the cash required for the DAP. Obviously, this requires co-operation from all concerned, and any time when beneficiaries are planning how they will treat assets after a benefactor dies needs to ensure that the benefactor’s interests remain paramount in the decision process.
An example of this might include where a relative who is not a protected person (say, a full-time employed adult only child who is the sole beneficiary of the resident’s estate) is living in a home that they wish to keep living in for the foreseeable future. That person may agree to pay, as ‘rent,’ the DAP for their parent’s accommodation. When their parent dies, the property simply transfers to them from the parent’s estate.
These arrangements should always be documented so that the intent of all people is clearly visible after the aged care resident has died.