Pension Loan Scheme: A viable alternative for older clients?

Is expanded Pension Loan Scheme (the Scheme) a viable alternative for retirees who are asset rich but cash poor? Extra cash flow can be useful whether it’s to pay for health care or simply to facilitate a better lifestyle. 

The Scheme is a reverse mortgage offered by the Commonwealth Government, drawn only as an income stream. A person can choose to receive capped fortnightly payments until their loan limit is reached. A person’s maximum fortnightly loan payment is currently the difference between the actual pension they receive and their relevant maximum rate of pension (including the pension supplement, energy supplement and rent assistance, if any). To date, very few people have used the scheme as retirees who don’t meet both the assets and income tests and full pensioners are excluded from the scheme.

To save on aged care costs the Government encourages older Australians to stay longer at home. However, clients with minimal assets apart from their home are unable to do so if they cannot afford support and care services delivered at home. In the past, there were calls to include the full value of the home in social security and aged care means tests or use home equity to help those with the means to contribute more for their care. To date, the home is a ‘sacred cow’ that remains exempt for the social security (includes Department of Veterans’ Affairs (DVA)) assets test. Present and previous Governments have not been willing to make it fully assessable.

On 1 July 2014, an asset test was introduced for new residential aged care residents. The asset test includes the value of the home up to a cap. 

The Government made changes to the Scheme to allow retirees access to home equity, so they have more money to spend. On 1 March 2019, The Social Services and other Legislation Amendment (Supporting Retirement Incomes) Bill 2018 became law. It contained changes to the Scheme to make it more sustainable and to allow more people to join the Scheme. From 1 July 2019, the following changes will become effective:

• the maximum fortnightly payment increases from 100 per cent to 150 per cent of the person’s relevant maximum pension rate;
• all pensioners and self-funded retirees who do not meet either or both means tests can join the Scheme;
• the ‘guaranteed amount’ is replaced with a ‘nominated amount’ from which the Government can recover any remaining debt; and
• new age component amounts will be used to determine the maximum loan available.

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For retirees who have minimal assets apart from the home, or whose investments are mainly in property, cash flow can be limited, and loans or lines of credit are difficult to get when a person has retired.

The home exemption is a valuable concession to pensioners. While it was recommended that it be assessed for the social security assets test it can significantly impact people who have no liquid assets and can force older Australians to sell their home. 

Rather than sell the home to unlock cash flow and risk losing the pension, the expanded Scheme is a less expensive form of reverse mortgage. The expanded Scheme may allow older Australians to live longer at home, receive additional cashflow to pay for home support services, home modifications, or pay for residential aged care, and retain their pension.

Who is eligible?

A person must meet the following conditions to join the Scheme:

• meet residency requirements for the Age Pension - the client must have lived in Australia and be an Australian citizen, permanent resident and/or a special category visa holder for at least 10 years including five years of continuous residence.
• be aged at least:
  • age pension age, or
  • if a veteran with qualifying service, a war widow or widower, be at least age 60.

The partner of a veteran must have reached age pension age to join the Scheme; and:

• not bankrupt and not subject to an insolvency agreement under the Bankruptcy Act 1966; and
• have property to offer as security for the loan and suitable insurance over the property.

Single and partnered clients can join the Scheme. If the person is partnered both partners must sign applications for the Scheme or to any change to the nominated amount (discussed below). 

What is the maximum fortnightly payment?

The Pension Loan Scheme loan is drawn as fortnightly payments – no lump sums are paid. The maximum fortnightly loan payment will increase to 150 per cent of the person’s relevant maximum pension entitlement (which includes the basic pension rate, the pension supplement and rent assistance, if eligible). A person can choose any fortnightly payment which is capped at the difference between:

• any actual income or asset tested pension and Defence Force Income Supplement Allowance received; and
• 150 per cent of their maximum pension entitlement.

Example 1:

Brian is single. The maximum single pension rate is $926.20 per fortnight (pf) (maximum single basic rate $843.60 pf, pension supplement $68.50 pf and energy supplement $14.10 pf) and 150% of this rate is $1,389.30 pf.

If Brian is a full pensioner he can choose any fortnightly loan payment up to $463.10, the difference between $1,389.30 and the $926.20 pf he receives.  

If Brian receives a part-pension of $500 pf he can choose a fortnightly loan payment of up to $889.30 ($1,389.30 less $500).

If he was a self-funded retiree, he may choose to receive a fortnightly loan payment up to $1,389.30.

Fortnightly loan payments are recalculated if the person’s pension entitlement increases so that their total pension and fortnightly loan payment exceeds 150 per cent of their maximum pension rate.

A person can choose to pause or change the amount of fortnightly loan payment at any time.

A person receiving a higher pension will have a lower maximum fortnightly loan payment while a self-funded retiree or a part-pensioner will have a higher maximum fortnightly loan payment.

The increase of the maximum fortnightly loan payment to 150 per cent of a person’s relevant maximum pension rate means those receiving little or no pension and drawing down the maximum fortnightly loan payment may hit their maximum loan limit sooner as the larger payments and compounded interest accrue at a faster rate. As soon as the maximum loan limit is reached loan payments cease.  

Security

The loan must be secured by Australian real estate owned by the client, their partner, or both. While the home is often used as security, multiple properties including rental properties and farmland can be used as security. Property held by a company or trust controlled by the person (if the person is an attributable stakeholder) can be used as security if the company or trustee guarantees to pay the debt when it’s due. 

To protect its interests and make the Scheme sustainable the Australian Government Solicitor will register a caveat or notice of charge on the property title.

A property with an existing mortgage may be offered as security, however the mortgage will be considered when calculating the maximum loan limit.

Nominated amount 

A person who wishes to leave an inheritance for family members might exclude a property or part of it or nominate an amount (previously the guaranteed amount) to be excluded from the calculation of the maximum loan amount.

The nominated amount or excluded property will reduce the value of security for the loan and as a result, will reduce the maximum loan amount. Unlike the guaranteed amount which cannot be used to pay off residual Scheme debt when the sale proceeds from the property sale is not enough to cover the loan, the nominated amount can be accessed to pay the remaining debt. The person may request an increase in the nominated amount if the asset under charge is enough to support their maximum loan limit.

Maximum loan limit

The maximum loan amount is calculated using the age component that relates to the client’s age at that time. The age component of the calculation ensures that the property held as security will be enough to repay the loan and factors in future interest and increases in property value. 

The maximum loan amount is calculated each year and is based on the:
value of the security (rounded down to the nearest multiple of $10,000) less:

• any nominated amount;
• the value of any life interest held by a person other than the person’s spouse; and/or
• an existing mortgage; and
• an age component amount based on the person’s age (if the person has a partner, then the age of the younger partner).

The Social Security (Pension Loans Scheme – Age Component Amount) Determination 2019 released a new Age component amount, as shown in table one.

The maximum loan amount is:

The age component amount X (the value of the security/$10,000)

Example 2:
Adrian (aged 80) and Mel (aged 75) are applying for the Scheme. The value of property held as security is $1 million. There is no existing mortgage or life interest registered over the property. Adrian and Mel elect a nominated amount of $375,000 to be set aside for beneficiaries of their deceased estate. The maximum loan amount is calculated as:

 $3,750 X ($620,000*/$10,000) = $232,500 

*$620,000 is $1,000,000 less $375,000 = $625,000 
rounded down by $10,000

The maximum loan amount is adjusted yearly as the age component amount increases with the person’s each birthday. 

Chart two shows the increase in maximum loan limits as a person ages from 70 to 90 based on a property valued at $750,000. 

Chart 2: Maximum loan limit increases with age

Source: IOOF

Interest rate

The Scheme is a lower cost option compared to other reverse mortgages. The interest rate, at 5.25 per cent per year since December 1997, on the outstanding loan balance compounds every fortnight until the loan is repaid. The rate is lower compared to reverse mortgages (6.24 per cent per year or higher) and the maximum permissible interest rate (5.96 per cent per year for new residents from 1 January to 31 March 2019) used in calculating the daily accommodation payment for residential aged care. 

Social security assessment

Social security treatment of a Scheme loan is more concessional than the general rule. A charge over an exempt asset like the principal home does not ordinarily reduce the value of assessable real property. The Scheme loan, however, will reduce the value of assessable property, such as rental property or a holiday home, where the loan is secured by the principal home and assessable real estate. Fortnightly loan payments are excluded from the income test. 

Example 3:

Scott is a single age pensioner. His only assets are his home, which is worth $700,000 and a holiday home, which is worth $600,000. He needs additional income but does not wish to sell either property. He offers both properties, totalling $1,300,000, as security to join the Scheme. If his outstanding Scheme loan is $200,000, his holiday home would be valued at $400,000 ($600,000 less $200,000). The home is exempt. He receives a fortnightly loan payment of $500 pf which is exempt income for social security and aged care means tests. 

As Scheme debt increases the social security assessment of the holiday home reduces (assuming no increase in property value), leading to increases in Scott’s Age Pension. Scott may choose to reduce fortnightly loan payments. 

Who can benefit

The Scheme may be suitable for clients who want to keep their property but who need:

• extra income to pay for home care and support services or residential aged care;
• to keep their pension but need more income; and/or
• other top-up income, such as rent or the pension to maintain a better lifestyle.

Keeping the home may protect a significant amount of assets from social security and aged care means tests. The client can save on costs of selling the property, the inconvenience of moving, or parting with a home which holds sentimental value for the client.

Other considerations

While a person can choose to repay the loan at any time, it must be repaid when the property is sold, or the person dies. If the surviving partner qualifies for the Scheme in their own right, repayment of the loan can be deferred until they also die. If the surviving partner does not qualify for the Scheme, the loan must be repaid after the 14-week bereavement period. Repayment of the loan should be discussed and planned for in advance so the person or their family can look at repayment options and avoid losses owing to a rushed sale of the property.

Paying the debt partially or fully where possible can save interest costs and decelerate increases to the loan balance so that more can be left to the person’s deceased estate. The person must notify Centrelink, or the DVA, if they become partnered, separated from their partner, or relocate to another home and the former home is held as security for the loan. These events trigger a review of pension entitlements and the fortnightly loan payment. If another property will be held as security for the loan, the old loan will be repaid and a new loan established. A person who separates from their partner must qualify for the Scheme in their own right. This is an issue if the person no longer has property to offer as security for the loan.

The Scheme is a loan and a financial advisor must have a credit licence to advise on the Scheme. Otherwise, the client should be referred to someone who has a licence or to a Social Security Financial Information Service officer.

Conclusion

Changes to the Scheme are designed to increase its uptake, especially as the maximum fortnightly loan payment has increased. Around 6,000 eligible pensioners are expected to join the Scheme over the next four years. The Scheme may be the answer for those who find reverse mortgages too expensive. It also allows people to draw on their own resources for their needs, reduces reliance on Government subsidies and enables older Australians to remain in their home rather than enter residential aged care. 

Janet Manzanero-Caruana is a senior technical manager at IOOF TechConnect.