FOOL'S EYE VIEW
Property-Based Retirement Schemes

By Jane Mack (TMFJane)
June 10, 2002

Last month, the Financial Services Authority warned consumers and financial firms alike that they needed to become more pro-active in providing for retirement. It's not just that we're all living longer that is a cause for concern. The Government is shifting more and more in the direction of persuading the individual to finance his old age rather than relying on the State Pension – mainly because there are going to be far too many of us oldies and not enough youngsters to finance us in the future. Companies are also beginning to move away from offering final salary schemes because they don't want to make promises they might not be able to keep. Either way, the responsibility of providing for one's old age is rather more in the hands of the individual than it used to be.

However, in their report, Financing the Future: Mind the Gap, the FSA also fired a broadside at the financial services industry by questioning whether they were ready to handle the increasing numbers of old people. After all, they have a responsibility to the consumer too as well as to themselves. The FSA's Carol Sergeant points out: "The consequences of an ageing population have not yet been fully appreciated. There are risks here, but there are also opportunities for innovative products and services that address the changing needs of consumers. It will not be enough for the industry simply to continue offering the products that worked 30 years ago."

So, it was no surprise to see in the Sunday Times yesterday that Standard Life Bank has been working on a new property-based retirement product that will allow you to use the capital value of your home as a form of pension. Similarly, the estate agents, FPD Savills, is about to offer a service which helps people to buy second properties instead of or alongside a pension scheme so they can live off the rental income in retirement or realise the capital.

Now, excuse me if I'm being a bit thick here but haven't both of these ideas been around for donkeys' years?

To be fair to Standard Life Bank, they say they're a bit puzzled by the Sunday Times story. Their plans are still only in the research phase and they're not claiming that it's a new idea – it's just another product to add to their selection should they decide to go down that road.

But, as far as I'm aware this type of product is called an equity release scheme and, although they've only recently grown in popularity, they've been around for about 25 years.

It's worth examining these in more detail so you know how they work. They're specifically aimed at older people who are property rich but cash poor, ie: those who have a lot of equity wrapped up in their homes but don't want to move in order to release it. These schemes are like reverse mortgages and there are all sorts of different types of plans you can go with but they all chiefly divide into two main types.

The first is the reversion plan. Here, you agree to sell all or part of your home to another party. When you move home or pass on, they then take their share of the proceeds. The main disadvantage with these schemes is that you will have to suffer a substantial discount from the actual market value. In fact, it's estimated that you'll only get between 35% and 60% of actual market value in most cases, as well as missing out on the likely future growth in the value of your home. It's clear that this is not a very cost-effective option.

The second type is the rolled-up loan. You receive the value of the loan (which you can take as either capital or income) and the interest you would normally pay is rolled up year after year. The loan plus the interest is then repaid when you move house or pass on. Here, the disadvantage is that the loan plus interest may roll up to such an extent that it could even exceed the value of your home. Many schemes under the Safe Home Income Plan now guarantee that you will never be forced out your home and offer fixed or capped rates of interest. The rates are, of course, higher than you would get with an ordinary mortgage (sometimes twice the Bank of England's base rate) because the lender is more restricted in the security they have over the property and their money is tied up for an uncertain length of time.

It's highly likely that this sort of scheme will become quite popular in the years to come as more and more people retire. Most of us haven't saved enough for a decent pension and there aren't exactly a lot of alternative options. But it's hardly an 'innovative product' and banks such as Northern Rock are already offering them.

And what about the new service that Savills is about to offer? Presumably I don't need to explain the idea behind it since landlords have existed for centuries and you can't have failed to notice the explosion in the market over the last two years or so. It's called 'Buy to Let'.

More: Pensions Centre | Homeowning Centre