How pensions are paid from our housing wealth

If you get a pension paid by Legal & General, you are probably being paid in monthly charges against other people’s houses. The £400,000, your neighbour borrowed against their £2m property is, according to figures provided by the Equity Release Council, rolling up at an average 5.77% interest meaning that Legal & General will get repaid an estimated £708,000 by the time the couple are expected to both be dead.

The final charge on the house depends on future rates of interest, how long the couple survive and the capacity of the house to hold its value. Legal & General are taking little risk with the deeds to the property in their charge and the longer the loan lasts – the better.

If you get a pension paid by Legal & General, it’s either because you worked at L&G or because the pension scheme you were in your working life, was sold to the insurer at a hefty premium to the scheme’s normal valuation, as a buy-out.

Back in 2018, actuaries Barnett Waddingham estimated that 25% of new buy-outs were funded by the proceeds of equity release, insurers using the money received from pension schemes to lend to retired homeowners and then paying pensions from the increasing charges on their homes. With the resolution of regulatory disputes between the PRA and the insurers over the solvency implications of this practice, this number is likely to have risen.

This is a source of long-term profit for insurers and has led to a boom in such lending. And there is no shortage of pension schemes ready and willing to buy out or of retired people ready to raise money against their houses.

According to the Equity Release Council , demand for Equity Release is increasing despite the increased cost of borrowing. Record numbers of UK homeowners are taking advantage of higher property prices to cash in on the value of their homes using fixed-rate equity release products. This from the FT

Lenders are now well on track to exceed last year’s record total of £4.8bn — which was itself far ahead of the previous biggest figure — £3.94bn in 2018.

Legal & General estimate that 1p in every 90p spent by people in retirement is spent from borrowings under equity release.

This recycling of our nation’s wealth is particularly important today. Many of the people borrowing against their houses are doing so because they are housing rich and income poor. Equity release schemes (unlike Retirement Interest Only mortgages) are granted without reference to the borrower’s income – there being no repayment or capital or interest on  the debt till death. So – as long as you have plenty of free equity in your property, you can use equity release to pay yourself an income in retirement. The debt is even offset able for inheritance tax purposes.

Are there any snags?

As ever, Martin Lewis has handy tips for those who don’t have an adviser (and those who do but want to understand the rules of the game for themselves).

For instance , for  the really poor homeowner, pension credit may be a better bet than mortgaging the home.

More generally, using the nation’s housing wealth to generate income to pay pensions is fine so long as there is a ready supply of buyers for the housing when the debts come due. This means a younger generation , perhaps the borrower’s children, being able to take over the debt with their own mortgage or from savings. There is some credit risk for the lender , but it’s small.

Looking 20 years down the line , there is no reason to suppose that house valuations will decline dramatically, but I wonder how much wealth is building up in our children’s hands and what capacity they will have to take on the debts we leave them. The snag from the borrower’s perspective, is what happens to the house when they die. But parents can argue that the debt may mop up money that would otherwise have been paid to HMRC in inheritance tax, more importantly, a lot of equity release money is used to get the next generation onto the housing ladder – with the prospect of their own housing wealth.

But , this whole circular economy is exclusive. If you are not part of the house holding society, then you are not going to get your retirement income from equity release, and you won’t get your kids on the housing ladder.

And the housing affluent today, are the most likely to be in receipt of the very pensions the likes of Legal & General are buying out.

Equity release is for the have’s, it does not solve the nation’s problem with later life financing.

A product in its prime

There is a finite source of DB pensions and quite possible a finite market for equity release.  But with pension increases capped at 5% and with current fixed rate deals on equity release borrowing at 4.27% pa, insurers look likely to fill their boots over the years to come. Here are projections from a recent survey commissioned by Legal &  General.

Equity release is in its prime, it helps pay other people’s pensions and it can help pay yours (if you own a home and you’re over 55). Right now, it is the perfect boomer’s product.

Getting a good deal is something a financial adviser can help you with, but be careful, whenever there is a large amount of money involved, there will be sharks as well as dolphins. The Equity Release Council , which has done a lot to raise standards in both the product and advice/sales has a membership of advisers which you can access via this link.

At a time when many of us may be struggling to see the wood for the trees, a conversation about your home may be timely.