The importance of housing in retirement

The main problems with superannuation are the low, and falling, rates of return, the fees being skimmed off it, and the fact that your savings might get blown up entirely by an incompetent or corrupt financial adviser, not the tax concession.

Rapidly rising life expectancy, the collapse in both interest rates and investment returns, and high fees, are combining to overwhelm the effect of the (shrinking) tax break.

That’s especially true in Australia, where super contributions and earnings are taxed instead of, as in most other countries, remaining tax-free till the end, and then fully taxed (which would be a better system, but it’s too late for that).

As a result, the big retirement question for most people is not how much they’ve got in super, and whether they might have to pay some tax on it, but whether they’ve paid off a house. The difference between going into post-salary old age paying rent or mortgage interest and living in a fully owned house that isn’t counted for the pension, and in which equity can be freed up, has become enormous.

Which is why the question of whether a family starting out can afford to buy a house, or is faced with a lifetime of renting, is the most important issue about their retirement.

That’s especially so in an era of declining returns and longer life.

The 10-year bond yield is now 2.3 per cent and the total return from the sharemarket over the past 10 years (including the GFC) is 4.2 per cent per annum. Most predictions suggest the return over the next 10 years is unlikely to be much better.

As a result, the cost of private annuities is rising and account-based pensions are not being replenished at a greater rate than the required withdrawals.

Meanwhile actuaries are now calculating life expectancy for 65 year olds at 90 for males and 92 for females — based on current medical science. And the general assumption is that once the current retirees reach, say, 80, medical advances will have stretched their lives even further — which is great news, except for the cost.

And of course once the 30-year-olds of today reach retirement, their life expectancy will be still greater. There might even have been a cure for cancer by then, God forbid.

In a way, low investment returns are laying bare the importance of housing at both ends of life: for those retiring, the value of the house, and the question of how much can be freed up by downsizing, has become hugely important; for those starting out, the price of housing is equally important — the other way.

Paying down the principal on a mortgage remains a good way to get a tax-free lump sum in retirement and given the political toxicity of taxing the family home, always will be. It’s true that those “contributions” are fully taxed but the final sum is capital gains tax free.

And for most people, whose super contributions have stayed within the concessional cap, the proceeds of downsizing can be paid into super as a non-concessional contribution within the lifetime cap of $500,000 and produce tax-free retirement income.

But it’s a generational problem: the higher house prices remain, the better off those over 50 will be; if house prices crash, they’ll be left high and dry but their children will be able to afford to buy a house early and not end up renting or still paying off a mortgage when they retire.

None of this would matter so much if investment returns were better, but the fact is they are not, and won’t be for a long time.

For example, the average super fund return since the GFC has been 9 per cent. Saving $500 a month for 40 years with that rate of return produces a final sum of $2.3 million.

The same savings plan using a 5 per cent rate of return — which is likely to be the after-fees going rate in future, at most — produces $763,000.

Big difference — especially if you’re renting.