Accommodation is usually the largest cost associated with the move to residential aged care, frequently requiring the sale of assets. Strategies to fund accommodation are a key aspect of aged care advice.
There are mechanisms in place for residents with very little means to have their accommodation subsidised by the Government, however, there will still be many who will need to pay the published price (or agreed amount) for their chosen aged care home. The average maximum published price is $391,000 across Australia and $423,000 in major cities but can often exceed $1 million in some areas.
The Aged Care Reforms effective 1 July, 2014 provided more flexibility for residents to meet the cost of accommodation. They can pay their accommodation as a refundable lump sum, ongoing payments or a combination of both, and have 28 days from their date of entry to decide how to pay.
Where a person does not pay for their accommodation as a lump sum, they effectively borrow the unpaid amount from the aged care home as an interest only loan. The repayments on the loan are the actual ongoing payments for their accommodation.
The maximum permissible interest rate (MPIR) for ongoing payments is set by the Government and is 5.96 per cent as at 1 July, 2018. This rate is reviewed and can change quarterly, however, the rate that applies throughout a resident’s tenure (unless they change rooms) is set at the date of entry.
If a person pays for their accommodation as a part lump sum and part ongoing payments, they can pay the ongoing payments from the lump sum. However, every time the ongoing payments are deducted from the lump sum, the person is borrowing more from the aged care home, therefore increasing the ongoing payments.
There are many strategies to fund lump sum and/or ongoing accommodation payments, and depending on the resident’s circumstances, some can work better than others.
Sell existing assets
Selling existing assets and using the proceeds to fund a lump sum accommodation payment can make a lot of sense in many situations. A lump sum payment effectively reduces ongoing payments by a rate equal to the MPIR. Where the existing asset is providing returns that are below the MPIR, selling that asset to make a lump sum payment can improve outcomes.
Additionally, a lump sum payment is exempt under the Centrelink/DVA means tests, which means paying a lump sum will effectively convert an assessable asset to an exempt asset. This could potentially increase Centrelink entitlements.
Note, existing assets sold with capital growth, for example shares and/or an investment property, may have capital gains tax implications. Additionally, a client will no longer benefit from any future income and/or capital growth from those assets.
Keep or sell the former home
Keeping and renting the former home can help with funding ongoing accommodation payments where there is a preference for retention or where the former home cannot be sold. For example, the individual may want to retain the home within the family or there may be a family member who is occupying the home.
Additionally, the value of the home will continue to be exempt under the Centrelink/DVA Assets Test for two years1 after the individual enters residential aged care. After two years, however, the home will become assessed and the individual will be considered a non-homeowner. This may lead to a reduction in Centrelink entitlements.
Previously, rental income could have been exempt from the Centrelink/DVA Income Test and/or the aged care means test if the individual made ongoing payments.
Since 1 January, 2017 the rental income exemption has been abolished, however, grandfathering provisions apply to those who entered residential aged care before this date. Net rental income for individuals entering residential aged care on or after 1 January, 2017 will be assessed under both the Centrelink/DVA Income Test and the aged care means test.
Note, income tax may be payable on rental income and there may be land tax implications depending on the state. Capital gains tax may also apply on the sale of the home. If it is sold within six years, the individual can choose to have the home treated as their main residence and access the main residence CGT exemption.
In many cases where the former home is sold to fund the lump sum accommodation payment a client may be left with a large capital surplus, creating further advice opportunities for the investment of these funds.
Loans from family members
Family members may be able to provide financial assistance to fund lump sum and/or ongoing accommodation payments. This provides time for the family to sell the former home, particularly where markets are unfavourable or the home was in a retirement village.
If a lump sum payment is made by the family member, the amount will be exempt under the Centrelink/DVA means tests for the aged care resident but will be assessed under the aged care means test. This could potentially increase the means-tested care fee.
Additionally, where the loan is not secured against the former home, the full value of the home will be assessed under the Centrelink/DVA Assets Test after the two-year exemption period for the aged care resident. This may lead to a reduction in Centrelink entitlements.
To protect family members who are providing financial support, a formal loan agreement should be considered. This can assist with reducing the risk of disputes on the death of the aged care resident, particularly where lump sum payments are refunded to their estate.
Accessing equity in the former home
Where family members do not have the capacity to provide financial assistance, accessing equity in the former home using an equity release loan can provide the funds for lump sum and/or ongoing accommodation payments.
As with a loan from a family member, an equity release loan can help with providing some flexibility and time for the family to sell the former home. If the loan is taken as a lump sum, the amount will also be assessed under the aged care means test.
The reduction in ongoing payments should be weighed against any increase in the means-tested care fee as well as the cost (interest) of the equity release loan. If the cost of the loan is the same as the MPIR, the added cost of an increased means-tested care fee can mean that it is more worthwhile to take the loan as regular payments (where possible) to meet cash flow requirements.
Note, interest on an equity release loan is usually capitalised, which helps with cash flow but increases the loan amount over time and the net value of the former home will reduce by the loan amount which should be reflected in the resident’s estate.
Sean Howard is Technical Services Manager at Challenger.