This week saw the launch of Legal & General’s Income Lifetime Mortgage plan, following hot on the heels of October’s release of the Saga Regular Drawdown plan. So why the sudden interest for income generation in the equity release industry? Are lenders vying for position, creating their own niches, or actually listening to consumers’ demands and needs?
This article looks at why equity release providers feel this product has legs, afterall no equity release scheme since Northern Rock has provided a monthly income payment plan. We’ll look at how it works, whom it suits, compare L&G’s Income plans and discuss alternative equity release income options.
Equity release has traditionally been a lifetime mortgage that provides a cash lump sum at inception. Today many versions exist such as drawdown, voluntary payment and enhanced schemes. However, all these schemes offer one thing - a lump sum of money. They usually come with the option of taking more tax-free cash in the future should circumstances dictate.
Background to Equity Release Income Schemes
In my 20 years of advising, only one income producing lifetime mortgage has been available to the whole of the market and that was pre-credit crunch days - Northern Rock. This was an inflexible plan, in that you couldn’t alter income payments. However, it did have a fixed lifetime interest rate and no early repayment charges. Therefore, if you needed to change your retirement plans, maybe even switch schemes, no penalty was charged on leaving Northern Rock.
Since the withdrawal of this product over 10 years ago we have seen unprecedented growth in equity release, without seeing any income generating products. Hence, will new income equity release plans help the market, even add to the momentum with something that’s not been around for a decade?
What’s Happened to Pension Income Over Recent Years?
There are many factors that maybe leading towards this tide of change. These are mainly economic and legislative factors that are starting to affect retirement income for the UK pensioner population.
We’ve now had sustained low interest rates, where interest from savings and investments has been reduced to the point where savings in real terms have actually declined as a consequence of higher inflation. Longevity and average life expectancy rising have seen annuity rates fall, with resulting income from them declining. Additionally, state pension age has been extended, therefore people are having to work longer before receiving their pension.
Following annuity reforms and the introduction of pension freedoms in 2015/16 tax year, anyone over age 55 can now take their whole pension as a lump sum, with 25% being tax free & the rest at their marginal rate. In just over 3 years since pensions freedom over £21.7 billion has been withdrawn from pension schemes this way. HMRC data on 2nd November 2018 stated almost 5 million withdrawals have been made by over 1.3 million people.
I’m just setting the scene, showing how collectively all these factors are beginning to stoke up income issues for the UK’s retired population. For these reasons, we are starting to see equity release providers manoeuvre to try and resolve how this growing problem of income shortfall can be addressed.
What is the Legal & General Income Lifetime Mortgage?
Following consumer research, L&G understood there was a demand for a fixed monthly income that provided a disciplined approach. They were being told people felt comfortable taking equity from their homes as an income, not just as a lump sum, in order to improve their retirement lifestyle. So, for those customers looking for a fixed income, equity release can now offer an alternative.
Do I Qualify & How Does the L&G Income Lifetime Mortgage Work in Principle?
The LandG Home Finance Income plan offers an alternative to lump sum and drawdown equity release. Rather than taking a large upfront payment, instead a fixed monthly income can be withdrawn and paid into a bank account of which one of the applicants must be a party to. This will be on the first working day of each month.
The L&G Income Lifetime Mortgage can be tailored to suit an individual’s needs, by selecting an initial lump sum and then a monthly income over a specific term. The minimum initial loan is just £2500, which should cover any set up fees.
All homeowners must be over the age of 55 with a property value of at least £100,000 (£150,000 for ex council properties). The minimum income is £200 per month can be paid to coincide with the requirements of the applicants over 10,15,20 or 25 years. No income term can be selected that would take any individual over age 105.
Once the income has been fixed, it will remain at this level until the end of the term and cannot be altered for the duration. The income is tax-free and can be stopped mid-term without penalty, however it cannot then be restarted.
At the end of the plan term, the income stops. The balance thereafter continues to attract interest and continues until the last person has died or moved into care. At that point the property would usually be sold & the lifetime mortgage balance repaid from the proceeds.
If required, optional voluntary payments can be made to repay capital/interest once the income payments have stopped. This can help control the roll-up of interest thereafter and is limited to 10% of the amounts withdrawn. Therefore, in any 12-month period upto four payments a year can be made, subject to a minimum of £500 with no early repayment charge (ERC).
How are the Levels of Income Calculated?
Legal and General Home Finance offer four versions of their Income Lifetime Mortgage - Income, Income Plus, Income Max and Income Max Plus. They are selected dependent upon how much income is required, Income Plan being the lowest whilst the Income Max Plus offering the highest. As with most equity release schemes, the higher the loan-to-value, the higher the interest rate becomes.
The calculation of the product and corresponding interest rate is dependent upon how much of an initial lump sum is required. This is capped at 10% of the maximum loan calculation. Additionally, the term of the income payment will also affect the size of the loan as L&G still protect the consumer & their beneficiaries with the Equity Release Council’s mandatory ‘no negative equity guarantee’.
The effects of age, LTV, initial loan and term on the interest rate can all be evidenced below.
A male aged 65 with a property valued at £300,000, over an income payment term of 10 & 20 years could choose any of the following:
10 Year Fixed Income - Maximum Loan
|Plan Name||Rate (MER)||Max Loan||Max Initial Loan||Max Monthly Income|
|Income Max Plus||5.97%||£113,700||£11,370||£926.66|
20 Year Fixed Income - Maximum Loan
|Plan Name||Rate (MER)||Max Loan||Max Initial Loan||Max Monthly Income|
|Income Max Plus||5.97%||£129,600||£12,960||£529.58|
So, what can we gather from these results?
In this example, if he required a £10,000 initial lump sum, there would only be the choice of either the Income Max, or Income Max Plus. The choice of plan would then boil down to the level of income required.
Obviously, the longer the term, the greater the loan will run and inevitably compounding of interest is greatest. Legal and General use this as the basis of their income calculations.
Therefore, you will receive a higher amount of income each month over a shorter term, than over the longer term. However, in total equity/income received over the periods, the longer term plan means more will be withdrawn from the estate:
- 10 years - Income Max Plus = £111,199
- 20 years - Income Max Plus = £127,099
Thus, it will be important for all applicants to gauge the effect of this extra borrowing & compounding of the interest. For a personalised illustration to see the effects of this please call the Equity Release Supermarket Freephone - 0800 802 1051.
What is the Maximum Amount I Can Borrow?
Two contributing factors govern the level of borrowing; age and term of the income. As with any equity release, the loan-to-values (LTV) rise the older you get. Currently, on the Income Max Plus, L&G’s highest LTV plan, a 55-year-old could borrow 25.9% of the property value over 10 years, compared to 31% over 25 years.
At age 65 the figures change to 37.9% and 45.3% respectively.
The reason for the lower LTV over 10 years, is that the income payable is higher for the duration, and with the Income plan, even after the income has ceased, the plan will continue to be charged interest for the lifetime of the loan. Actuaries have been working overtime!
Interestingly, the loan-to-values for this new Income Lifetime Mortgage plan are higher than L&G’s standard roll-up lifetime mortgage range. Currently, L&G’s highest LTV is on the Flexible Max Plus Plan is 53% from age 85, whereas the Income Max Plus Plan over a 25 term would offer a LTV of 65.7% from age 82.
The reason L&G can afford to do offer higher LTV’s on the Income plan is due to the compounding effect of interest on a monthly balance starting from as low as £2,500, which is much lower than interest charged on a lump sum plan starting from a much higher level.
What are the Income Plan Set Up Costs?
Usual costs apply to the L&G Income plan. Equity Release Supermarket can obtain an unlimited free valuation of your property on application. From there Legal and General will charge an application fee of £599, which can be deducted or added to the loan amount. A telegraphic transfer fee of £30 is charged when transferring funds to your solicitor. The only other associated costs would be your legal fees and any advice fee from your financial adviser.
Who Would Benefit from an Income Paying Equity Release Scheme?
As mentioned earlier, there are more people reaching retirement, either having immediate shortfalls in income, or the problem will exacerbate over time with inflation.
This can be due to a number of reasons such as poor pension planning, being forced to retire earlier than anticipated, or maybe not being in receipt of their pension benefits yet.
Pension freedoms have created a new income shortfall category - those having withdrawn significantly at age 55, thereby leaving themselves short of income for later in life.
For all these reasons, the over 55’s may therefore need an injection of income to supplement their lifestyle for a variety of reasons:
- Continue to afford household bills and expenditures
- Meet loan or credit card obligations
- Treat themselves to regular holidays
- Have the ability to afford life’s luxuries and days out
- Bridge income shortfall before commencement of a state pension
- Replace income created by the loss of their partner
Why Choose an Income Plan Rather than a Drawdown Lifetime Mortgage?
Drawdown lifetime mortgages are the most popular equity release scheme accounting for almost 75% of plans written in H2 2017 (ER Council report Spring 2018). They allow you to manage your equity release scheme using the similar principles as an Income plan; you are allocated an overall cash facility from which you take an initial lump sum. Rather than a fixed income, you have the option to take ad-hoc withdrawals from the remaining cash reserve, but in amounts and frequencies you choose. There no additional charges for each withdrawal.
So, the ultimate choice over an Income or Drawdown plan is governed by the required discipline. If you want a fixed income and interest rate, then the lender controls these with an Income plan. However, if you want flexibility over frequency of income and the amount taken, then a drawdown plan would seem best.
This is somewhat over simplified, as many other factors need to be addressed and would be analysed during the research phase by your local Equity Release Supermarket adviser – state benefits being just one.
The Effect of Income Lifetime Mortgages on State Benefits
One of the main drawbacks as an adviser recommending this Legal & General Income Lifetime Mortgage is the inflexibility of the income and the potential effects on means tested benefits. This is not just at inception of the plan, but possibly later in life. According to L&G, HMRC have classed any income withdrawn under this plan as income that can potentially affect entitlement to means tested benefits.
Means tested benefits that could be impacted under this ruling are universal credit, council tax reduction and guaranteed pension credit. We would always recommend a full assessment of your benefits at this point.
Another impact this income could have is later in life with a joint L&G Income Lifetime Mortgage plan. Should one partner die, the survivor could be placed in a situation where without the Income Plan, they would have been entitled to means tested benefits. The decision therefore needs to be made as to whether to stop payments on the Income plan and then apply for state benefits.
However, by stopping the income plan means that payments cannot be restarted later, or any additional lump sums of money can be withdrawn under this scheme. In the future, should the need for extra income or capital arise, consideration would need to be given to switch the plan to another product or even lender. The potential downside of this is the punitive L&G gilt-based early repayment charges of upto 25% that could be levied. Specialist advice and discussions with the family are therefore advisory.
In my opinion there is plenty to think about for both customers considering L&G’s Income Plan, advisers who are recommending it, and also lenders who need to develop the concept and flexibility of these schemes for the future of the market. Yes, income plans will have a part to play, albeit, not to the levels of the more established plans we have today…a ‘ripple effect’ maybe. There are other income options and these should always be explored as part of any retirement planning strategy.
However, it gives the consumer a greater choice of products and shows homeowners and consumers alike that this equity release market is innovating and evolving. That is a positive message thanks to Legal & General and hopefully other lenders and funders should take note and build upon what L&G have started.
If you wish to discuss any aspect of this Legal & General Equity Release article, please call the Equity Release Supermarket team on FREEPHONE 0800 802 1051 or email [email protected].