As professional advisors we often hear the same story from our older clients: they have worked hard, their adult children have left home, and they have some savings and superannuation. Their most valuable asset is the family home which is unencumbered.
Asset rich and cash poor is a common position amongst our ageing population. However, what if the client wants or needs access to liquid funds? What if staying in the family home is no longer a viable option? As a lawyer or a financial advisor, it is important to get the full facts and always remember that "one size" does not fit all. So, what are the possible options for someone who is asset rich and cash poor?
If the client's goal is to simply have access to liquid funds for the purposes of travel or a greater income stream, then it may be appropriate to downsize.
Downsizing involves the sale of the family home, and a subsequent or simultaneous purchase of a cheaper dwelling, often smaller in size.
The family home, regardless of its value, is an exempt asset for pension purposes.
The benefits of downsizing are:
- The client retains legal ownership of the new dwelling; and,
- The client has access to cash funds.
However, the benefits must be weighed up against the disadvantages, in particular:
- The expenses associated with the transactions, such as a real estate agent's commission, marketing expenses and legal costs for the sale and purchase of property, as well as ad valorem stamp duty on the purchase of the new dwelling; and,
- The potential impact that the extra cash funds may have on the client's Centrelink benefits as the cash funds or any physical asset purchased with those funds will be considered an 'asset' for income and means testing purposes.
Families often want to retain the original family home for sentimental purposes, or other reasons, for as long as possible. In this case, a reverse mortgage may be an appropriate course of action.
A reverse mortgage is an arrangement whereby a lending institution advances a cash lump sum to the client secured against the client's family home, with no repayment obligations until the property is sold or the client dies. At Coleman Greig we find that clients frequently don't realise that this is an option.
Under the Social Security Act, reverse mortgages are referred to as "home equity conversion agreements" and the funds realised from the family home's equity in that manner are specifically excluded from the income test. The end result is that the client:
Still lives in the family home, which is exempt for pension purposes; and,
Obtains access to cash funds, which are also exempt from the income test.
However, great care must be taken when advising clients about reverse mortgages particularly with respect to interest rates, ensuring that the repayment only be required on death and that the mortgage can be transferred to a subsequent property.
At Coleman Greig we also find that it is important for the client to make their children aware of their decision to obtain a reverse mortgage to avoid confusion and potentially disputes on their death, which is already a sensitive time.
A 'granny flat' typically refers to self-contained accommodation, often a smaller freestanding house or a private area in the main house (for example, an entire floor fitted out with bathroom and kitchen), where the older person lives. This type of living arrangement is designed to provide the person with independent style-living close to family members who can help care for them as and when required.
Care must be taken not to confuse the colloquial understanding of 'granny flat arrangement' with 'granny flat interest' in the eyes of the Department of Human Services.
According to the Department of Human Services a granny flat interest is an agreement for accommodation for life and in order for a valid granny flat interest to exist in a property, the following requirements must be satisfied:
The property must belong to someone else. More specifically, it must not be owned by the person, his/her partner, a trust or a company which the person controls;
- The property must be all or part of a private residence;
- It must be the person's principal place of residence; and,
- The person must have an irrevocable right to live in the property for life.
In summary, a granny flat interest is created when the person exchanges money or assets (or both) in exchange for a life-long right to live in someone else's property. A common scenario may be where a client transfers the property he/she legally owns to a child in exchange for a right to live in that or the child's property for life, often accompanied by the child promising to care for the parent(s) but this is not a formal requirement.
Although this may seem like an attractive option for some people, the importance of obtaining financial and legal advice before entering into the transaction is invaluable and cannot be stressed enough.
It is equally important for the child in the described circumstances to obtain financial advice as granting a life interest to the parent is likely to amount to 'creating a contractual right or other legal or equitable right' - the D1 event for Capital Gains Tax purposes.
An improperly implemented granny flat interest can have drastic consequences; impacting the person's eligibility for a pension, or the rate of payment.
In summary, without careful planning and consideration, the client may have his/her pension cancelled altogether and the child may be hit with Capital Gains Tax. Failure to properly document the granny flat arrangement may also leave the client destitute in the event of family conflict, most commonly either a falling out with the child or the child separating with his/her spouse or partner and/or commencing a new relationship.
Another important consideration in cases where the parent has more than one child is the divesting of the family home, which is often the most valuable asset and therefore a great share of their estate, in favour of only one child. This will almost always drive a wedge amongst the siblings, causing a dispute either at the time of the transaction or following the parent's death.
Retirement villages are an increasingly popular option for older people and provide greater security of accommodation than granny flats.
To be eligible to move into a retirement village, residents must generally be over 55 years old or retired from full time employment or be a spouse/partner of such a person. Different operators offer different legal structures, but most commonly the person acquires either a strata title or a leasehold interest.
Retirement villages are a secure option of accommodation and can often cost less than downsizing however, caution must be exercised and consideration must be given to fees that may be involved, including:
- Upfront costs - usually a lump sum payment similar to buying a house. This is often referred to as a 'ingoing contribution';
- Ongoing costs - often referred to as 'recurrent charges' which may include strata levies, management costs, council and water rates; and,
- Departure costs - including a 'departure fee' and/or sharing of capital gain between the operator and the outgoing tenant.
Any person considering moving into a retirement village should always engage a legal advisor to review the contract and a financial advisor to provide advice on the financial consequences of the transaction.
In conclusion, the right option for the client will depend on their circumstances and their objectives but regardless of which option the client chooses to pursue it is recommended that financial and legal advice be obtained to avoid unexpected adverse consequences.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.