An evolving later life market

Bob Champion | Later Life Academy
10th April 2019
Bob Champion LLA Later Life Academy
"The interest on a RIO must be affordable. Not only when it is taken out but over the remainder of the mortgage. "

The Retail Distribution Review (RDR), Pension Freedom reforms and the Mortgage Market Review (MMR) together may have created a difficult environment for retirement interest-only (RIO) mortgages to flourish and without innovation could create issues going forward.

The RDR, for instance, resulted in many advisers deciding that they would advise on retail investment products e.g. pensions and investments, or mortgages and protection but not both. The Pension Freedom reforms have turned the retirement income market on its head. Before the reforms 10 annuities, providing guaranteed income for life, were sold for every pension income drawdown account opened. Now the opposite applies. Then the MMR introduced more stringent affordability criteria that for some have made it difficult to move mortgage providers.

Following a relaxation in FCA criteria as to who could advise on later life mortgages, we have seen a new product introduced - the RIO mortgage. However, there is now some concern about the low take-up of this product.

According to surveys, more than 20% of over-50s say they intend to use their housing wealth to augment their pensions in retirement. But, according to an FCA freedom of information request from the Daily Mail, in 2018 only 112 RIOs were sold. This compares with over 80,000 new equity release customers. Then there are the unknown number who withdrew equity by moving house.

This is probably an unfair comparison in that RIOs are a relatively new product. I wish it every luck because in my view all consumers are different, and the larger the number of product options, the better the chance the consumer will arrive at the best possible solution for their retirement finances. There are however several barriers to the future success of the product.

Firstly, it is reported that mortgage advisers do not feel they have sufficient knowledge of the later life market to recommend the product. This is understandable. Where a younger mortgage applicant may be expected to work for the next 25 years there is a strong probability that they will continue to have a similar income for the remainder of their working lives.

In the approach to retirement, assessing future income becomes more complicated. How will the individual move into retirement? Will they just stop work or scale down their working hours? When will they begin to implement their retirement plans and for how long will any transition take? How will these events revolve around payment of their State pension entitlement? This is just a snapshot at understanding the customer. Will they stick to their plans? A life event could throw the best laid plans out of the window.

The interest on a RIO must be affordable. Not only when it is taken out but over the remainder of the mortgage. If the borrower has a defined benefit pension, how much of the tax-free lump sum can be used to reduce the mortgage? Remember the client may have other debts that may need to be addressed. Are the commutation terms good value? For a client in good health it may be a wise decision not to commute their DB pension.

Spending in retirement will also be different to spending while working. Will the DB pension income be sufficient to show the RIO interest is affordable? Defined contribution pensions are more complicated. There are numerous options as to how they can be used.

If RIOs had been available before the Pension Freedom reforms it may have been safe to assume that tax-free cash would be taken alongside an annuity purchase. This creates a similar position to a DB pension although attention needs to be given to ensure any partner has sufficient income following death of the annuitant. Due to restrictions that applied to the amount of withdrawals, the drawdown option would not have created many issues.

The Pension Freedom reforms have turned this upside down. The assumption must be that pension income drawdown will be used but now there are no restrictions on what can be withdrawn. If you assume drawdown will be used, how much income needs to be drawn and will this be sustainable? Sustainability in some part depends upon the underlying investment mix. This could introduce the concept of stochastic cash-flow projections into the world of mortgage advice.

Are we however starting in the wrong place? We are starting with the product and how you justify using it rather than looking at what is best for the client and arriving at the best product. To do otherwise could lead to the client doing what is not in their best interests, for example, taking out an annuity just to produce the income to justify a RIO.

Take this example where a potential RIO client owns a home. They are looking at ways of using the equity in that home to make more efficient use of their assets to help better enjoy their retirement or to meet a particular objective. There are a variety of ways this can be achieved, but each has an impact on how other assets, for example, pensions and investments are used. The other assets available and how they can be used should also affect the recommendation as to how housing wealth should be used.

To get to the right recommendation, requires holistic knowledge of the retirement space. No wonder some mortgage advisers are avoiding the later life market but, in my view, they are being short-sighted. The recent growth in equity release sales shows how fast the later life lending market is going to grow and it’s likely to become an ever more important part of the sector. Of course, to be part of it requires good knowledge on all aspects of the later life market, but there is plenty of resource and support available – not to actively involve oneself would effectively be cutting off the advice nose to spite the face.

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