If, however the decision is financially motivated, then the first step should be to discuss other options and view the house as the client's one remaining significant asset, or indeed if they still have a mortgage that needs to be paid off, whether it's worth considering an equity release (often called a lifetime mortgage) type product.
There is no hiding the fact that these plans acquired a terrible reputation towards the end of the last century with clients slipping into negative equity and the executors of their estates having to pay back more than the house itself was worth, but the good news is that the equity release industry has undergone a complete sea change and many equity release products are now a viable option for some.
The Equity Release Council is the industry body for the equity release sector and represents the providers, qualified financial advisers, lawyers, intermediaries and surveyors who work in the equity release sector. All the members of this group must agree to a code of conduct which includes:
- Giving the client the right to remain in the property for life or until they need to move into long-term care (provided the property remains their main residence);
- The right to move to another property subject to the new property being acceptable to the product provider;
- And most importantly - a “no negative equity guarantee”. This means that when the property is sold, and agents’ and solicitors’ fees have been paid, even if the amount left is not enough to repay the outstanding loan to the provider, neither the client nor their estate will be liable to pay any more.
These plans are basically just a traditional mortgage, but with the option for the client to "roll up" the interest payments for life or until the property is sold. In some cases the funds can be used to repay a traditional mortgage product, if the existing plan has an upper age limit or the client's income is no longer high enough to sustain the level of borrowing.
This differs significantly from the similarly named home reversion scheme. Unlike the equity release/lifetime mortgage option, where the client remains the owner of the property, this type of plan requires that the client sells all or part of their property at less than its market value in return for a lump sum, a regular income, or both. They are allowed to stay in the home as a tenant, paying little or no rent, but have no ownership of the property. These plans are extremely rare but it is important to differentiate between the 2 types of plan.
For many clients what they do with any funds released from downsizing can be one of the most important decisions they will make in their life. The most important thing for them to consider is what they wish to achieve from this money, for instance, do they need it to:
- Produce an income?
- Pay off debts?
- Simply provide a "cash cushion"?
- Or can they afford to gift it away to the next generation? (Perhaps in order in order to help with their Inheritance Tax planning?)
Those who wish to use the funds to produce an income have quite a few decisions to make:
- Do they wish to maintain the value of the capital whilst still drawing an income?
- Can they produce the income they require by simply placing the funds in a bank account?
- And if not, how much risk are they prepared to take to ensure that they have an appropriate income for the rest of their lives?
The key thing here, of course, is that by simply placing the funds into a bank account, it is very unlikely that the funds will maintain their "real value" when inflation is taken into account, especially if the interest is being drawn along the way. This means that in many cases, individuals look towards asset-packed investments such as fixed interest securities, equities and managed funds.
I have found that for clients in this situation, setting out a cash flow plan is particularly useful, as they can assess any risk that must be taken and the potential downsides to this. Paying off debts is, in my mind is one of the most important steps to take as this could be one of the last "cash injections" individuals will receive and by paying off any debts that are being serviced (especially higher interest debts such as credit cards, store cards and loans), they can significantly improve their net income position.
It goes without saying that we would always advise clients to keep some rainy day money and a normal rule of thumb would be enough to cover 3-6 months of outgoings. This ensures that individuals do not need to tap into their investments at an inappropriate time if any emergencies arise.
Lastly, the decision regarding whether to gift funds away is always particularly difficult as many families have a fear of gifting funds down to the next generation, in case these funds are not used in a way in which the parents approve of. Unfortunately by gifting funds directly, there is no way of being in control over how this money is spent and many therefore prefer to place funds in trust. This can be a useful "middle ground" between retaining the money themselves and gifting it directly, which means that they give up the right to draw the lump sum themselves but still retain control of it, and can therefore decide when, and if, any funds are gifted to the potential beneficiaries.
In all the options outlined above, there is more to the decision than simple figures. This is when we as financial planners would call on the knowledge of other experts within Morton Fraser in order to ensure the clients get the best advice possible.