Chapter 05 – Special Case – the Family Home

The Family Home and Residential Aged Care – To Keep or not to Keep?

The family home is a special case in retirement and aged care planning.

Dover has a different view of the family home than many AFSLs. Basically, we recognise family homes as the cornerstone of most people’s wealth. So, our starting point is that the family home should usually be retained whenever possible.

That said, no two clients are the same. Each situation needs to be taken on its merits. The following sections discuss the interplay of the family home and aged care planning and talk to general themes that need to be addressed in financial planning for aged care.

In this section, we have assumed that the family home is owned without any debt financed against it. If there is debt, perhaps via previous use of a reverse mortgage, then the net value of the family home (rather than the market value of the home) is the salient figure.

Benefits of Retaining or Selling the Family Home

The potential benefits of retaining a family home include:

  • Reducing the asset base for calculating the means-tested care fee payable;
  • The retention of an asset from an asset class that has traditionally done as well or better than any other asset class;
  • The ability to borrow against the home;
  • The ability to derive rent from the home;
  • Maintaining exposure to capital growth in cases of relatively long stays in residential care;
  • Maintaining wealth in a CGT-free investment type;
  • Personal wellbeing benefits from knowing that the family home has been retained; and
  • Potential compatibility with inheritors’ plans (the potential for elder abuse needs to be assessed whenever the best interests of someone other than the elderly person are being considered).

The potential benefits of selling a family home include:

  • Being able to pay cash for the Refundable Accommodation Deposit (‘RAD’) required by most homeowners when entering an aged care facility;
  • Achieving an effective rate of return of 6.14% when paying the RAD as a lump sum;
  • Avoiding the need for complicated financial management, such as the use of reverse mortgages or the management of a tenancy;
  • Freeing up cash flow to be used for other lifestyle choices, such as paying for extras in the aged care facility; and
  • Simplifying affairs, especially in cases where there are multiple people affected by any decision.

For a further discussion of the benefits of keeping or selling a family home, please read this article by John Teale of Professional Planner

The Decision to Keep or Not Keep – Key Factors to Keep in Mind

In determining what to do with the family home, there are a number of particular factors that should influence the decision. These are discussed in the following sections.

The Home is usually the Major Asset

For many, if not most, older people, the family home is typically the major asset that they own. In cases where a person may have retired with substantial super, these benefits have often been drawn down by the time an aged care facility looms.

For example, according to the Australian Institute of Health and Wellbeing, only 8.7% of residents of aged care facilities are self-funded retirees. The overwhelming majority claim either a DVA or a Centrelink pension. This tells us that they have relatively few assets outside the family home (which is exempt from the assets test for these benefits).

Accordingly, the decision regarding the family home will be the most significant decision that the client is likely to make (or have made on their behalf).

Frailty

Residents contemplating residential aged care are necessarily frail. Accordingly, it is common for at least one other person to be involved in their financial management.

Often, this goes well. But the reliance on someone else can raise issues to do with propriety. Put simply, it is not uncommon for an older person’s children or grandchildren to start to see the family home as their own once their older relative goes into an aged care facility. In one particularly memorable case, we observed a family home that was promptly sold and the proceeds use to buy new cars for the next two generations, who literally referred to themselves as having received an inheritance. All while mum was still alive in the nursing home.

Interestingly, the Office of the Public Advocate in South Australia has seen fit to remind people that they simply do not have a right to an inheritance before the donor’s death.

For an adviser, the older person’s reliance on someone else can raise some ethical issues. The ‘best interests’ of the elderly client are not necessarily the same as the ‘best interests’ of the eventual beneficiaries of the clients’ estate. Advisers need to be on the lookout for ‘elder abuse,’ which can include financial abuse.

Elder abuse can be researched further, and reported, via the My Aged Care website. In addition, Seniors Victoria have published a useful guide for lawyers working with clients who may be at risk of elder financial abuse.

Regarding the family home, elder abuse can lead to the house being inappropriately kept or inappropriately sold. For example, children (or some other person) might decide to keep the family home, but not facilitate it being used to finance an appropriate level of residential care. This might happen if the children live in the property without paying market rent, or do not facilitate a reverse mortgage against the house, etc. The older person lives in a less comfortable manner than they need to, while others make use of their major asset.

In contrast, children may insist that the property be sold but then not direct all of the proceeds to financing the owner’s aged care (as in the case above, when the home was used to buy cars for its owners children and grandchildren). Importantly, where assets are removed from an older person (for example, if the family home is sold and the descendants all buy new cars), the Centrelink and Aged Care rules will still count those assets as belonging to the aged care resident. 

Powers of Attorney and Trustees

Ideally, where frailty has become an issue, an older person will have granted one or more powers of attorney to some other person to act on their behalf. This will include making decisions regarding the family home. The power of attorney legally empowers the other person to make decisions on behalf of the older person.

The key thing for the attorney to remember is that they have a fiduciary duty to act in the best interests of the older person. This means that the older person’s interests must take precedence over any other person’s interests – including the attorney.

The Length of Stay in an Aged Care Facility

One of the most difficult factors in deciding whether a client should retain a family home is the fact that the length of stay in an aged care facility cannot be predicted with any great certainty.

According to the Australian Institute of Health and Wellbeing, the average length of stay in an aged are facility, as of 2011, was around 145 weeks, or just short of three years. Stays were shorter than this for men and longer for women (and 70% of residents are women).

145 weeks is simply an average. There is substantial variation around that number. 27.1% of people stayed for less than two years, while 20.5% of residents stayed for more than five years (this figure was slightly higher in major cities).

So, relatively long stays in aged care facilities are common: 1 in 5 people who enter residential aged care will still be there 5 years later. The system takes this fact into account in various ways. One is the lifetime cap on the means tested care fee payable by residents. This fee is capped at $61,754 for life. Another is the fact that the RAD does not increase once a resident has moved into a facility.

Residents using debt, such as a reverse mortgage, to pay some or all of a DAP may find that the amount of debt starts to approach the limits of the loan facility as the years pass. Simple investment analysis tells us that the net equity in the home should not be affected, as long as the growth rate on the home keeps track with long-term averages. But growth can be lumpy, and so a plan for what happens if the debt starts to approach its limit makes sense.

The best plan, of course, is to minimise the amount borrowed.

Obviously, prudential financial planning dictates that longer stays in residential care be assumed.

The presence of a ‘protected person’

A protected person is someone whose continued presence in a home after the owner (or co-owner) moves into residential care has the effect of exempting the home from the assets tests that apply to aged care. There are four categories of protected person. These are:

  1. The resident’s spouse or partner;
  2. A dependent child or student;
  3. A residential carer of at least two years standing and who is entitled to a Centrelink benefit on the day the resident moves into the aged care facility; or
  4. A close relative who has lived with the resident for at least five years and who is entitled to a Centrelink benefit on the day the resident moves into the aged care facility.

The presence of a protected person means that the value of the family home is not counted towards the assets test for either the means tested care fee or the accommodation fees. In most cases, then, where a protected person remains in the family home, there is an economic rationale for keeping the family home.

Not to mention the fact that the protected person still needs somewhere to live!

The absence of a protected person.

Where there is no protected person, the decision as to whether to keep the family home becomes just that: a decision. The client and their adviser need then to decide whether and how to keep or dispose of the family home.

Capital Gains Tax

One issue that is often a good one to keep in mind is that the principal place of residence CGT exemption that applies to a family home continues for up to six years after a person leaves the home, as long as they do not claim another principal place of residence.

In addition, where a principal place of residence forms part of a deceased estate, then there is a two year period following the death of the owner during which the CGT exemption continues to apply.

What this means is that the CGT-free status of a family home can continue for up to six years following the owner’s entry into an aged care facility.

Alternative uses of the proceeds of any sale of the family home need to be weighed against this feature of the family home.

The Family Home and the Fees Payable in Aged Care

There are three types of fee that will definitely be levied on home-owning residents of aged care facilities, and a fourth that probably will. The three ‘definites’ are: the accommodation fee, the basic daily care fee and the means tested daily care fee. Of these three definites, the basic daily care fee will not vary depending on the decision made regarding the family home. This leaves two definite expenses that will be affected.

The probable fee is the additional ‘extra care’ fee that may be charged by the facility for additional things such as recreation.

This analysis will restrict itself to discussion of the two definite fees that are affected by the decision as to what to do with the family home.

Means Tested Daily Care Fee

The means tested daily care fee includes the family home among assets used for the assets test for this fee, but only to a limit of $157,051 and only if there is no ‘protected person’ living in it. As a starting proposition, this preferential treatment for the family home often creates a financial benefit to keeping the family home.

The reason for this is simple: while the family home continues to be held, no more than $157,051 of its value counts towards the assets test. Once the home is sold, the proceeds of the sale of the family home count in full towards the assets test. Presuming the family home is worth more than $157,051, this increases the relevant asset base. So, keeping the family home generally leads to a lower means tested care fee.

There are some situations where the means tested daily care fee will not be affected by the decision regarding the family home. These situations include where the value of other assets is so high, and/or the size of the resident’s income is so high, that the maximum means tested daily care fee will be payable anyway. In those cases, the impact on the means tested daily care fee of selling or keeping the family home can be ignored. The decision can be made on other grounds.

The specific impact of the decision on keeping or retaining the family home will vary according to the specific situation in which a client finds him or herself.

Accommodation Costs

While a decision as to whether to sell or keep the family home will impact on the means tested care fee, the effect is probably quite marginal. It is in deciding how to pay the accommodation costs that the decision about the family home becomes more fundamental.

Accommodation Costs – Deposit or Daily Payment?

Accommodation costs will almost certainly be payable by anyone who owns a home. This is because the upper asset threshold for these costs is just $157,051. This threshold includes the family home, and very few homes are worth less than this. So, most people with a home will exceed the threshold. The exception might be home owners from outside of major cities, regional centres or towns.

There are two ways to pay the accommodation costs. The first is to pay a Refundable Accommodation Deposit (RAD). This is the whole cost of accommodation and is negotiated with the aged care provider. The provider is obliged to advertise the maximum RAD payable on an available room. There is often scope for residents to negotiate a fee that is actually lower than this – especially in a facility with vacancies.

The second is to make a Daily Accommodation Payment (DAP). This payment, expressed on a daily basis but in practice paid on a monthly or quarterly basis, is calculated as a percentage of the RAD. The maximum percentage is currently 6.14%. Thus, the daily amount is 6.14% divided by 365 multiplied by the RAD.

For example, if the negotiated RAD is $400,000, the RAD is $67.40 per day.

A Critical Figure – The Maximum Permissible Interest Rate

Financially, the critical figure in deciding what to do with the family home is really the maximum permissible interest rate. As of December 2015, this rate is 6.14%. A resident moving in to an aged care facility must pay either a one-off RAD or a daily payment equal to an annual 6.14% of the RAD.

These pages assume that the maximum permissible interest rate is being charged. If a lower rate applies for the particular aged care facility, then that is the rate that is critical to the financial decisions.

When it comes to the RAD, if a resident can achieve a rate of return greater than 6.14% via some other investment, they are better off making that investment instead of paying the RAD. They would then pay their accommodation expenses as a DAP rather than as a lump sum. If they cannot achieve a rate of return that exceeds 6.14%, then they are better off paying their accommodation expenses as a RAD. The RAD gives them the superior rate of return.

To give a simple example: a resident with $100,000 in a cash management account earning 2.4% would be better off withdrawing the cash and using it to pay the deposit. The cash management account is earning (roughly) $6.75 per day, being the $2,400 annual interest divided by 365. Using the $100,000 to pay a lump sum towards accommodation saves $16.82 per day, being 6.14% of the $100,000 divided by 365.

As a guaranteed rate of return, 6.14% is hard to beat. Therefore, where there are assets outside of the family home, these assets should typically be used to pay the refundable accommodation deposit. This saves the resident 6.14%.

However, the rate of return on residential property has long exceeded 6.14%. So, as a starting point it can be said that retaining the family home is likely to be a good option where possible. This is particularly the case where the RAD is less than the value of the family home, such that the extra proceeds would have to be invested elsewhere anyway. (This assumes, of course, that the family home is a representative one).

Paying a RAD While Keeping the Family Home

For some people, keeping the family home and paying a RAD are not mutually exclusive. A RAD can be paid in various ways. These ways include:

Borrowing a lump sum against the family home, or some other security. Some residents may simply be able to borrow an amount to pay the RAD. If the rate of borrowing on any such loan is less than the effective interest rate used for a DAP, then this will work well. For example, if the DAP is 6.14% and the interest paid on a loan is 5.14%, there is a 1% arbitrage available. If a client borrows $100,000 to pay all or part of a RAD, they will pay interest on the loan of $5,140. But they will negate DAPs of $6,140 per year. They are $1,000 better off.

Care should be taken here to first ascertain what interest rate is being applied by the aged care facility. As its name suggests, the maximum permissible interest rate is the upper limit of what can be charged. Some facilities may charge a lower rate.

The most common way to borrow for a RAD is to use some form of reverse mortgage. Clients may also borrow from other sources. For example, a client may borrow the money from an adult child or grandchild. The child or grandchild may even finance the RAD themselves by borrowing at some cost lower than the MPIR.

One thing to be aware of here: any amount paid as a RAD on behalf of a resident will count as an asset when that person is means tested. This asset can be offset if the amount is properly cast as a loan, as there will be an offsetting debt. A formal loan agreement is therefore a good idea in such a case.

Such an agreement also ensures that the money used for the DAP does not become a gift to the resident, which may then see it included as an asset under that person’s will.

Using other assets to pay the RAD. The effective rate of return on money used to pay the RAD is currently 6.14%. This is guaranteed, in the sense that it negates a known cost: if you pay the deposit, you are guaranteed to avoid the cost. This is a higher rate of return than most residents will be able to achieve on any cash or cash-like investments. So, a client with cash should generally use that cash to pay some or all of their RAD.

To give a simple example: a resident with $20,000 in cash will receive no more than 1% or so (if that) as interest on that amount. If they use that money to pay some of a RAD, they will reduce their DAP’s by $1,228 per year.

Having someone else pay the RAD. A similar logic to that which applies to using other assets to pay the RAD can apply where there are other people involved with the resident. For this discussion, we will assume that the resident has a ‘child’ who may be able to pay some or all of a RAD. (That ‘child’ is likely to be in or over their fifties, but we will call them a child regardless).

That child, for example, may have some cash that is being held in a cash or cash equivalent account. The interest being received will almost certainly be less than the 6.14% that could be obtained by making a RAD. Using the money to instead pay all or part of the RAD will maximise the family’s financial position, because the resident’s costs will be reduced by more than the revenue given up by their child.

It could even be the case where the child charges the parent an interest rate that is the same or more than what the bank would pay, but that is less than 6.14%. For example, if cash was earning 2% in the bank, the child could use it to pay the DAP and ask the resident to pay them 2% to compensate for the lost interest. The child is in the same situation, but because 2% is less than 6.14%, the parent is still better off.

Once again, something to be aware of is that any amount paid as a RAD on behalf of a resident will count as an asset when that resident is means tested. This asset can be offset if the amount is properly cast as a loan, as there will be an offsetting debt. A formal loan agreement is therefore a good idea in such a case.

Such an agreement also ensures that the money used for the DAP does not become a gift to the resident, which may then see it included as an asset under that person’s will. Where there are other beneficiaries under a will, for example other siblings, this inclusion could be a problem. A loan agreement will avoid that problem.

Ways to Pay a DAP when the Family Home is Kept

The alternative to paying a RAD is to pay a DAP, calculated by applying an interest rate (currently capped at 6.14% – December 2015) to the RAD that would be payable.

This alternative requires the resident to be able to access either a lump sum to pay the RAD or cash flow equal to 6.14% of the RAD each year. 

As we have said elsewhere, there is little point in keeping a cash ‘float’ to be used to pay a DAP. This is because the cash would earn an effective 6.14% if it was used to pay at least part of the RAD. So, this analysis assumes that the resident needs to obtain cash flow from some regular source to finance the DAP. There are three broad options. 

Rent the family home to a tenant. The tenant may or may not be related to the resident. The average yield for a rental property in an Australian city is 3.5%. Allowing 0.5% of these receipts as costs, this leaves about 3% available for the property owner. On its own, this will not be enough to pay the standard DAP in cases where the RAD is the same as, or close to, the value of the property.

If the RAD is less than half of the value of the property, then the rent received should cover most, if not all, of the DAP. Similarly, if the yield on a particular property is higher than the average, then the ability to pay a DAP is increased.

Please note that rent received by renting the family home may have a negative effect on any aged pension that the client is receiving. The aged pension is subject to an income test. In addition, the rental income will also count as income in the income test for the means tested daily care fee test (this change took effect from 1 January 2016). If the rent exceeds the income threshold for the means tested care fee, then 50% of the excess amount will be counted toward this fee. However, this fee is also subject to an annual and a lifetime cap, such that the ‘cost’ of earning rent, in terms of increased means tested care fees, is limited to no more than these caps.

Borrow Against the Home. The second option is to borrow against the home (or some other asset, including assets owned by another person, such as a child’s home). This is essentially a reverse mortgage, although often a better rate of interest can be obtained by taking a simple line of credit loan secured against the property. The borrowing against the property can be kept to no more than 6.14% of the value of the RAD.

Basically, the resident or their representative organises for a periodic direct debit to the aged care facility from the loan account.

Of course, this option can also be used in conjunction with the option to rent the family home. The property may be able to be simultaneously rented and borrowed against.

Use Cash Flow Derived From Elsewhere. A third alternative is to use cash flow derived from elsewhere. This may mean income derived from other assets, such as investment properties or shares. As stated elsewhere, typically it will not include income derived from cash or cash-like investments such as term deposits, because the resident could obtain a better effective return by using that cash to pay some or all of their RAD. But if income from other sources is sufficient, then using this income to pay the DAP can be a good move.

Remember, paying the accommodation expenses as a DAP is tantamount to borrowing at the relevant interest rate (currently 6.14%). This means that it can make sense to retain other assets that can be expected to grow at a rate greater than this. As a long-term proposition, and on average, such assets have historically included residential property and Australian shares.

An alternative source of cash flow might also include other generations within the family. These people may wish to retain the family home for personal or investment use, and could thereby agree to provide the cash required for the DAP. Obviously, this requires co-operation from all concerned. In addition, in situations where beneficiaries are planning how they will treat assets after a benefactor dies, care needs to be taken to ensure that the benefactor’s interests remain paramount in the decision process.

An example of this might include where a relative who is not a protected person (say, a full-time employed adult only child who is the sole beneficiary of the resident’s estate) is living in a home that they wish to keep living in for the foreseeable future. That person may agree to pay, as ‘rent,’ the DAP for their parent’s accommodation. When their parent dies, the property simply transfers to them from the parent’s estate.

These arrangements should always be documented so that the intent of all people is clearly visible after the aged care resident has died.

The Dover Group