Doing the numbers on downsizing

Summary: The costs associated with selling a home must be weighed up against the benefits of contributing more to super or choosing a reverse mortagage. 

Key take-out: Those considering a DSC should do the numbers and assess the potential impact on their age pension.

The question of whether the new Downsizer Super Contribution is worthwhile depends on each person or couple's individual circumstances. What cannot be debated is that the new contribution does mean that, where it makes sense for someone to use the proceeds from the sale of a home to increase their super, they will now be able to do this no matter what their age is after July 1, 2018.

When considering whether to make a DSC it is important to look at what alternatives there are. Where a person or couple want to improve their lifestyle in retirement, have very few assets and investments, and the main asset is their home, the alternatives are to either take out a reverse mortgage or sell their home.

If a reverse mortgage is used there are costs involved related to upfront fees charged, ongoing fees, and interest charged that is compounded over the period of the loan based on the principal amount borrowed.

Canstar Blue, a customer satisfaction research and ratings business, estimated the total cost of repaying a $90,000 reverse mortgage loan (at a Lending Value Ratio of 15 per cent and based on average interest rates and average fees paid) is $91,783 after 10 years, $259,431 after 20 years, and $572,131 after 30 years.

If it is decided to sell a home and purchase a new home that costs less than the value of the current home, with the excess sale proceeds being used to help fund retirement, the costs are the usual selling and purchase costs for any real estate transaction.

As a general rule the selling costs of a property are between 2 to 3 per cent of the selling value. Purchase costs include approximately $1000 for legal fees plus stamp duty, which varies between the states.

This means for an existing home that sells for $1.5 million, selling costs vary between $30,000 and $45,000. After reviewing stamp duty rates for a number of states, the average stamp cost is 4.5 per cent for homes under $1 million, which on a replacement home costing $900,000 would be $40,500.

On a cost basis, where the current home is worth $1.5 million, and the replacement home costs $900,000, the total cost would be approximately $85,000. Also see The downsides of downsizing.

If the owners of the home took out a reverse mortgage on their $1.5 million, using a 15 per cent LVR at average interest rates and costs, based on the Canstar Blue findings, the cost would be $229,458 over 10 years, $648,578 over 20 years and $1.43 million over 30 years.

DSCs and the age pension

The cost of a downsizing transaction is not the only thing that should be considered when deciding whether or not to use this strategy compared to a reverse mortgage. Another cost that should be considered is the effect that a DSC has on a person or a couple's eligibility to receive the age pension, compared to using a reverse mortgage.

Interestingly the effect on the amount of age pension received is exactly the same, whether the home is sold or a reverse mortgage is used. In both cases retirement assets counted by Centrelink are increased by the net proceeds produced. This is because a reverse mortgage over a home cannot be used to reduce the value of the investments that the proceeds of the loan have been used for.

When it comes to the assets and the income tests for the age pension I wondered whether, in the event a replacement home is not purchased and a person or couple moves into an aged care facility or retirement village, it would be beneficial to not pay a refundable deposit but instead pay a higher daily accommodation contribution.

I had hoped that rather than having an ownership interest in the form of a refundable deposit, and given under Centrelink rules these deposits are not counted under the assets test, the higher daily accommodation amounts paid would be classed as a form of rent, resulting in the higher non-homeowner assets and income tests thresholds applying.

Unfortunately the test that defines a home owner or a non-homeowner is based on two tests. The first is where the age pension recipient has a right or interest in the place they occupy, while the second is where the right or interests gives them reasonable security of tenure.

This second part of the test would mean not paying a refundable deposit, but opting for a higher daily accommodation charge, which does not alter the security of tenure of the person or couple living in the age care facility or retirement village. Thus they are still regarded as home owners.

In the final analysis the assessment of whether to make a DSC contribution, which involves going through the costs and work involved in selling and buying a home, must not only be assessed against the costs but also the benefits.

I estimated a $600,000 super contribution with earnings of 7.7 per cent per year (the average earning rate for SMSFs over a five-year period according to the ATO's 2015 statistics) and an annual pension drawdown of 7 per cent would grow to approximately $689,000 over a 20-year period.

This means, using the example of the existing home being worth $1.5 million, the replacement home costing $900,000 and $600,000 being made as a DSC using the above earnings and drawdown rates, over 20 years the increase in the superannuation is greater than the estimated sale and purchase costs.

Compare this to a reverse mortgage of 15 per cent, of a home worth $1.5 million, which results in a total cost of interest and charges over 20 years of approximately $649,000.

What can be said with regard to using the DSC strategy to increase amounts held in superannuation, the less an age pensioner has now in retirement assets counted by Centrelink the more worthwhile it is to make a DSC contribution. The table below shows this, and for those who currently qualify for very little or no age pension it can make a great deal of sense to make a DSC contribution.