Homeowners vs renters in retirement

Homeowners vs renters in retirement, by the numbers

Retired actuary John De Ravin explores the outlook for retirees who own their home and for those who rent.

Your home is your castle”, according to the old saying, and Aussies really take that to heart, more than the residents of just about any other nation on earth. “

Some of the advantages of home ownership are obvious. For one, if you own your home, you’re not at the mercy of a landlord who can turf you out, or increase the rent at the end of each lease period, so owning your home means security of tenure. Also, if you own your home, you can decorate and renovate it as you see fit without needing to seek anyone’s permission. And there’s that indefinable feeling of attachment to a piece of physical earth, and a building, that brings comfort. But apart from those advantages, there are two benefits of home ownership that are distinctive to Australia. First, your ‘principal residence’ is an important exemption from our capital gains tax (CGT). Even if you sell your home for twice, five times, or even 10 times what you paid for it, you won’t normally pay a cent in CGT. The CGT exemption contributes to home ownership being a great investment. But the other thing, which is especially relevant for retirees and pre-retirees who hope to receive a part or full Age Pension, is that the Age Pension means testing arrangements in Australia are very generous to homeowners. In fact, regardless of how valuable your home may be, it isn’t counted in the assets test. You can own a $5 million home and, as far as Centrelink is concerned, that asset is worth precisely $0 when it comes to the assets test.

Case study: Bill and Mary Bill and Mary are 66. They are both recently retired. Because Bill’s employment involved many relocations, they never bought their own home. However, they have lived modestly and contributed to super, so they have built a decent financial asset base of $850,000, entirely in superannuation. Now that Bill and Mary are no longer employed, they want to settle down and stay in one place for many years, near their children and grandchildren. They are trying to decide whether to rent or buy. Let’s compare their situation according to whether they decide to buy or rent. The table below shows their income and expenses if they rent, compared to if they buy a property for $600,000, leaving $250,000 with which to take out account-based pensions.

Item of income or expenditure Income from account-based pension Age Pension Rental Assistance TOTAL INCOME Rent Other property expenses (rates, insurance) TOTAL PROPERTY EXPENSE NET INCOME TO SUPPORT LIFESTYLE BUY RENT $12,500 $42,500 $36,582 $16,692 $0 $3380 $49,082 $62,572 $0 $24,000

$3000 $0

$3000 $24,000

$46,082 $38,572

To prepare the table, it’s necessary to make some assumptions about the rent they would pay to live in a $600,000 property equivalent to the property they are thinking of buying. I’ve assumed they would pay an annual rental of four per cent of the property value. I’ve assumed that if they own their own home, they will have to pay annual rates and buildings insurance of $3000 that they would not have to pay if they choose to rent. And finally, the table assumes that whether they take out an account-based pension with $850,000 (if they rent) or $250,000 (if they buy a home), they will draw down on their account-based pension prudently at the statutory minimum rate of five per cent per annum (as many Australian retirees do). The Age Pension entitlements in the table assume they own $10,000 in non-financial assets as well as their financial assets.

So, you can see that Bill and Mary are much better off if they own a home. The main reason is that they get much more Age Pension if their assets are in their home (where they don’t count against the assets test) than if all their assets are held in their account-based pensions (where their assets are fully asset testable). Effectively, Bill and Mary will

receive an additional $16,510 in total Centrelink benefits (Age Pension plus Rent Assistance). Also, as owners, they will not have to pay rental expense. The upshot is that if they own their home, they will have $46,082 to support their lifestyle, but if they rent, they will have only $38,572. In other words, they will have 19 per cent more to spend on their lifestyle (other than their property expenses) if they choose to buy than if they rent. What’s more, the Age Pension is payable by the Australian government, and will be indexed to average weekly earnings, whereas their main source of income, should they keep all their assets in their account-based pensions, will be subject to the vagaries of the investment markets. Typically, their house will continue to grow in value, and will form a large part of their bequest to their children or other beneficiaries, whereas the balance of their accountbased pensions is likely to decline over time, especially if they survive beyond their mid-80s.

But what if you can’t buy a home? We saw above that life is financially more comfortable for couples who own their home once they reach Age Pension age (and the same applies to single Age Pensioners). If a couple, such as Bill and Mary, don’t own their home as they approach retirement but do have the financial assets to buy a home, it’s not too late. There is nothing to stop them from buying a home shortly before or shortly after they retire, and then collect the larger Age Pension that they may thereby be entitled to. But what about couples who are approaching retirement, but who don’t own a home and don’t immediately have the resources to buy one? Here are some of the strategies such a couple might consider. 1. Continue in the workforce longer to save, inside or outside superannuation, with a view to having enough to buy a house by the time they retire. 2. Consider moving to a less expensive location (perhaps a rural or regional location) if that means they will be able to afford to buy a home.

3. Undertake a little part-time work in retirement – but avoid earning more than the income test free threshold. 4. A non-homeowner couple should ideally target a level of assets, by the time the couple is eligible for the Age Pension, of about $650,000. Nonhomeowner singles could consider targeting an asset level of $550,000. While you will not receive a full pension if your assets exceed these levels, you would get almost the full Age Pension.

5. If you can’t afford to buy a home, consider moving to a location where rents are not too high a proportion of your Age Pension. Without a home, your lifestyle in retirement will be a bit more financially constrained, but a bit of part-time work and the right level of assets should produce a satisfactory lifestyle, even though you will have to continue paying rent.

John De Ravin is a retired actuary and author of Slow and Steady: 100 wealth building strategies for all ages. Slow and Steady, available from johnderavin.com, explains the key financial strategies that can help pre-retirees and retirees prepare for and enjoy the best retirement possible.

DISCLAIMER: All content in the Retirement Affordability Index™ is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances.