More Australians are unlocking home equity to fund retirement

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Vanguard’s recently released How Australia Retires study found that Australians with the highest confidence about their future retirement tend to take the most purposeful action to prepare.

For some Australians that purposeful action to prepare may include selling their principal place of residence at some point with the intention of freeing up extra cash to use during retirement.

The former Turnbull government moved to join the dots between downsizing and retirement five years ago when it commenced the “downsizer measure” from the start of 2018-19.

The downsizer measure enables eligible Australians to sell their home and then deposit up to $300,000 from the proceeds directly into their superannuation account. The measure also enables eligible couples to potentially deposit up to $600,000 from their home sale proceeds into their respective super accounts – $300,000 each.

According to data provided by the Australian Tax Office (ATO), over the period from 1 July 2018 to 30 April 2023 around 58,000 individuals have made downsizer contributions to their super to the value of $14.5 billion.

That equates to an average super contribution size of $250,000 per person from the downsizer measure.

Downsizer amounts are treated separately to standard non-concessional (after tax) super contributions, which allow eligible individuals to make contributions up to $110,000 each financial year or up to $330,000 up-front covering three years.

Downsizing in Australia

Australia’s rules around downsizing and super contributions are stringent.

Initially only available to homeowners aged 65 and over, the minimum eligibility age for the downsizer measure was lowered to 60 on 1 July 2022, and then again to age 55 from 1 January this year.

But age is only one of the many criteria that needs to be met to participate in the downsizer measure.

The ATO, which administers the measure, has an extensive list of eligibility criteria (and exclusions) on its website. They include a requirement that a home must have been owned for 10 years or more prior to selling, with ownership calculated from the date of settlement when it was purchased.

The key advantage of making a downsizer contribution into super is that any income earned on that money after age 60 is tax-free in pension phase.

In the retirement context, downsizing doesn’t always involve individuals shifting from a larger dwelling to a smaller one.

Downsizing as a strategy is about extricating equity, primarily for retirement purposes, which may also involve selling a home in a more expensive area and buying one in a less expensive area.

Downsizing in the U.S.

Of course, downsizing for retirement income purposes is not just an Australian phenomenon.

New research from Vanguard in the U.S. examining the strategy of unlocking home equity for retirement purposes has found that among Americans who retire and relocate, about 60% aged 60 and over move to somewhere less expensive.

They typically unlock about US$100,000 of equity from a home they may have purchased decades earlier.

Vanguard researchers analysed millions of migration records from the U.S. Census Bureau’s American Community Survey and housing price data from the Federal Housing Finance Agency to determine patterns of relocation around the time of retirement and throughout people’s lives.

Interestingly, they found sharp regional differences in how much value can be extracted from a home when a homeowner relocates upon retirement.

While homeowners originating from most U.S. coastal states have the potential to cash out a significant sum, Vanguard found those from the U.S. mid-west and south (with lower median property values) may need to inject principal or take out a mortgage to purchase an average-priced home in the new location.

This home price differential trend is likely to be similar across different housing markets in Australia. For example, there is a large gap between the median property prices in higher-cost capital cities such as Sydney and Melbourne and lower-cost capital cities, as well as across regional areas.

How much equity value can be extracted from a home for retirement income purposes ultimately comes down to prevailing property prices in the selling location, and prevailing prices in the buying location.

Implications for retirement readiness

Vanguard’s U.S. researchers found that while it’s well-known that home equity represents a significant source of wealth for many American households, how to use it has been less clear in the context of retirement.

Unlocking home equity by relocating to a less expensive housing market can provide a significant source of retirement funding.

“Recent records suggest that this strategy could be thoughtfully deployed by 25% of all U.S. retirees in the next 10 years, potentially significantly improving their retirement readiness,” the Vanguard researchers noted.

Australia’s downsizer measure effectively opened the door for many Australians to stoke their super balance (either before retiring or after retirement).

People considering making a home downsizer contribution into super – especially those already receiving a partial or full government Age Pension – should do proper due diligence.

Because the Age Pension is calculated on the value of all assets outside of the family home, including the amounts held in a super accumulation or pension account, a large cash injection from home proceeds may result in a breach of assets test rules.

There is a two-year asset test exemption for principal home sale proceeds for people intending to use the proceeds to buy another home. In addition, deemed income (for pension calculation purposes under the income test) on the exempt proceeds is calculated using only a 0.25% deeming rate.

It’s important to seek out professional financial advice, especially with respect to social security means testing.

By Tony Kaye, Senior Personal Finance Writer
June 2023
vanguard.com.au