Think about it

I recently heard a statement that if an adviser recommends an equity release plan, without having considered the alternative of a RIO, they could face a future complaint case to defend. The argument goes that if the interest rate on the RIO is much lower than an equity release mortgage then why is someone paying more for the debt?

I worry that regulators take that view also. Why else would we be in a situation where someone can be authorised to recommend a RIO yet not be qualified to recommend equity release products?

Like it or not, the quality of retirement depends upon your spending capacity. Spending capacity is determined by net income after tax and other unavoidable outgoings.

Let me give you an example of a situation I know well. A 65-year-old lady is divorcing after 40 years of marriage. When asked about the outcome she wants most, she says it’s to remain in her dream home. This is worth £900k. She needs to find £450k to buy her husband out.

Her husband’s pension rights are much greater than her own and she recently received an inheritance. If she can find £150k then she will be able to meet the outcome she wants most. However, her gross income will be £15k a year.

On a gross income of £15k she can expect to pay £500 income tax, leaving her with a spending capacity of £14.5k a year. Using an interest rate of 3%, the annual cost of a RIO will be £4.5k a year. This will come out of her after tax income, leaving her with a spending capacity in retirement of £10k a year.

This could possibly meet affordability criteria. Spending is dependent upon individual behaviours which are difficult to modify. Could a lady who is used to living in a partnership with a joint income in excess of £50k a year suddenly be able to live on her own with a net income of £10k a year? Remember a person living on their own incurs costs of a lot more than 50% of a couple living together.

An equity release mortgage could come with an interest rate of 5% per annum. This is the worry, on the face of it - how can an adviser recommend taking on debt at an interest rate that is 67% higher than that available under a RIO? Arguments could be made that the equity release mortgage rate is guaranteed for life while the RIO rate could rise once the guaranteed period had lapsed.

However, the danger is that if a complaint arises it may be reviewed following a continued period of low interest rates.

There is another aspect to be considered - Inheritance Tax. Following divorce, the lady in question, will not be able to take advantage of her partner’s nil rate band. Even after allowing for the maximum residential property nil rate band she will have to pay inheritance tax on her estate that is in excess of £500k.

Assume no increase in the value of her house and inheritance tax bands remain the same - not a wild assumption seeing that increasing house prices create the largest political pressures to increase inheritance tax thresholds. It would take over 22 years for the amount borrowed to reach £400k - the amount on which inheritance tax will have to be paid assuming no other assets. By the way it would take over 38 years before the loan reached £900k, the current value of the home.

What this indicates for this particular lady, and I admit that she is by no means typical, is that she can achieve her number one objective. The quality of her retirement will depend upon her retaining as much of her limited income as possible. The argument about the cost of debt has to be seen in this context.

Add to this the fact that the cost of compounding is going to offset Inheritance Tax liabilities at 40%, and then the equity release option becomes justifiable.

It is important that when making such a recommendation the reasoning behind it is fully evidenced and documented.

But where does that leave the RIO adviser who did not consider the equity release options?