Pension warning: 40 year mortgages to put ‘huge pressure’ on retirements & state benefits

Pensions: Money Box caller talks impact of age differences

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Mortgage products have had to adapt in the face of coronavirus and economic instability and in November, the number of mortgages with 40-year terms available sat at 146, according to Moneyfacts. The majority of these deals come with maximum ages of 75 – seven years after someone currently in their mid-thirties is likely to start receiving the state pension and 12 years beyond the average healthy life expectancy in the UK, according to the ONS.

Retirements placed in doubt

As 40-year mortgages become more prevalent, interactive investor warned homeowners, including first time buyers in their mid-thirties who are considering long mortgage terms, to seriously consider the implications for their retirement plans.

The company explained: “They might have to contribute significantly more into their pensions to cover their mortgage repayments after they retire, or be prepared to work for longer.

“However, ill health and other life events often prevent people being able to work for longer, even if that is their intention. This could put those with mortgages in later life at risk of not being able to continue to meet their repayments in old age.”

These issues were illuminated in recent months through interactive investor’s Great British Retirement Survey. Respondents, who had an average age of 60, typically had an average of 11 years remaining on the mortgage. This suggested when some retire, they will still have some form of mortgage, with 12 percent of respondents said they were worried they may never pay it off.

interactive investor continued: “Typically, ‘what you need’ retirement income scenarios assume that all housing costs are paid off. The rise of the 40-year mortgage, as well as a long-term increase in the number of people renting privately, means that an increasing number of retirees will have housing costs when they retire. For these individuals, the amount needed in their pension to cover living and housing costs could be far higher than the assumptions they are currently working towards.

“If they can’t meet this extra budget for housing costs through additional contributions to workplace pensions or through working into old age, they might end up exhausting any private pension provision built up far sooner. They would then be dependent on the state pension in their later retirement years.”

According to calculations by interactive investor, a 30-year old currently earning £27,500 is on track for a pension pot worth approximately £190,000 if they pay eight percent of their salary into a workplace scheme until they are 68. The PLSA estimates that £20,800 a year is enough for a moderate retirement income, including the state pension.

Additional analysis from the company showed that, based on average yearly mortgage repayments of £7,644, someone who has a mortgage to 75 would need private pension savings to deliver an income of £19,105, on top of their state pension, to age 75, to cover their living costs and mortgage. The pot worth £190,000 would run out at age 75 if it had to cover this full amount, leaving that person dependent on the state pension alone from that age. Without mortgage costs to 75, the pot would last until 79, at the PLSA moderate level of income.

Becky O’Connor, Head of Pensions and Savings at interactive investor, commented: ” The rise of mortgages with ultra-long terms that stretch way past retirement age is worrying. It requires a fundamental rethink of what people will need in retirement and could require a change to the assumptions that underpin current guidance for pension savers on how much they should aim to have in their pot.

“If you are considering paying a mortgage into retirement, there’s a huge reality check coming: you will need a much bigger pension than most people are currently on track for to finance this additional borrowing.

“Generally, mortgage brokers don’t interrogate people on their retirement plans, asking at what age someone plans to retire as part of the application process. It’s very hard for both borrowers and brokers to know at what age they will end up retiring though, and whether they will have enough pension to cover repayments, if they have to give up work earlier than they initially thought when they were applying for the loan.

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“It’s hard to project this far into the future when you are in your 30s and you may have an optimistic view of what you will be capable of, workwise, when you are 70. The difficulty is being able to guarantee the ability to continue working until 75, even if that is someone’s intention four decades earlier.

“When the auto-enrolment minimum was set it really was a minimum and assumes that it will provide enough in retirement for the average earner who also receives a full state pension and doesn’t have any housing costs when they retire.

“Unfortunately, the development of longer-term mortgages and the rise of private renting call these assumptions into serious question. If people have housing costs when they retire, they will either need a bigger pension or be able to work for longer – or face running out of money sooner.”

Ms O’Connor went on to examine how these mortgages may put “huge pressure” on the benefit system.

Benefits impacted

Currently, benefits such as the state pension and Pension Credit, are aligned with the income requirements of retirees who no longer have mortgage or rent costs. These benefits are not designed “to cope” with housing costs.

Ms O’Connor warned a monthly mortgage could add a further 80 percent again on top of what someone reliant on the state pension needs just to cover living costs.

She concluded: “It’s particularly a problem for those who suffer age-related ill health before they can receive their state pension and have to give up work, but still have large mortgage bills coming out. Income protection insurance is designed to step in to pay an income if you can no longer work due to accident or illness until your retirement age and is a useful product, but not enough people have it.

“This problem could be a slow and painful burn for the Government, as more people reach the point they have to give up work sooner than the end of their mortgage term. This could put additional strain on the benefits system, whether through working age benefits or pension benefits. The worst outcome for individuals could be that they have to sell their homes to repay the loans they can no longer afford, or take out equity release mortgages. These enable people to stay in their homes but reduce any inheritance they could leave to children.

“If equity release is used en masse to solve the problem of people not being able to repay 40 year mortgages when they reach retirement age, then what these borrowers could face is a lifetime of mortgage debt.”

It should be noted the Government has made efforts to boost the prospects of pension investments and aid retirement planning. Recently, the DWP outlined proposals to enable automatic enrolment pension schemes to make greater use of performance-based fees, which are payable to an investment manager only if they generate high returns on their investments.

Currently, these fees are included within the pension scheme charge cap, meaning they are rarely considered viable. However, if the proposals are implemented, these performance fees would be excluded from the charge cap, helping schemes – if they choose to utilise it – overcome barriers to long-term investment and provide new opportunities to invest in areas such as British businesses and green projects.

The intention is to make it easier for schemes to access new channels of investment – such as funding for new British start-ups and the infrastructure needed for the transition to net zero – known as “illiquid investments”. This move can offer greater returns to savers while continuing to ensure they remain protected from being charged high fees despite low returns.

Guy Opperman, the Minister for Pensions, commented: “As automatic enrolment has developed, we have always wanted to ensure the best outcomes for members. This consultation will look at ways to enable schemes to take advantage of long-term, illiquid investment opportunities and provide better returns for members.

“Lifting these barriers can also help contribute to the key role finance has in tackling climate change, by mobilising private finance towards clean and resilient growth and addressing market barriers to longer-term investing in green projects.”

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