Placing a parent in an aged care facility can be a distressing time for families. It is not a pleasant experience financially either.
Since the federal government introduced aged care reforms in July 2014, collectively families have been forced to find an extra $3 billion a year to move an elderly relative into an aged care facility.
In the future they may need to find even more.
The number of people aged 80 and above is expected to increase from one in 26 today to one in 18 by 2030, which is set to trigger a rise in demand for high-quality aged care accommodation.
There are two major costs for residential aged care: the accommodation fees and the care fees.
And as people’s expectations for aged care accommodation increase – such as the desire to private rooms with ensuites, secure areas, personally tailored services and highly skilled care staff – costs are likely to increase further, leaving many wondering how they are going to pay for it, says Deloitte Health Economics and Social Policy partner Lynne Pezullo.
Families wanting to hang on to the family home rather than sell it to fund a move into aged care need to look carefully at their options if they want a bed in the best facility available.
With accommodation costs in the top facilities regularly exceeding $500,000 and at times $1 million, increasing numbers of aging Australians will be forced to sell their home or look at the alternatives such as equity release strategies.
James Hickey, Deloitte Financial Services partner, says with rising aged care costs it is time for families to have a serious discussion about the role of the house.
“Should it be used to fund a comfortable lifestyle for mum or dad, or kept as part of an inheritance?” Hickey says.
Two key costs
But first, what costs are families up for?
Residential aged care may be heavily subsidised by the government, but for those who can afford it there are two major costs: accommodation fees and care fees.
The average so-called refundable accommodation payment (RAD) is $350,000 but it regularly exceeds $500,000 and can be more than one $1 million depending on the facility and its location.
The RAD can be payable in full or as a daily accommodation payment (DAP) or a combination of both.
Essentially, the RAD is the capital value of the room the resident is occupying, while the DAP is the interest rate set by the government, which is currently 6.22 per cent.
The care fees consist of a basic daily fee is equal to 85 per cent of the single rate of pension. Currently set at $47.86 a day, it is payable by everyone. Then there is a means-tested care fee which, depending on the financial position of the resident, can be up to $211.40 a day but is capped at $25,731 per year (or about $60,000 over a lifetime).
Some facilities offer extra-service rooms which can cost between $20 and $100 a day for services ranging from wine with meals to hairdressing or additional outings.
What are your options?
While the sale of the family home is a good source of capital and will help families avoid the government’s 6.22 per cent interest rate on aged care accommodation, the system actually rewards those who can afford to keep the house or unit – even if doesn’t make sense financially.
This is because the value of the family home is capped at $157,987.20 for the purpose of the means-tested care fee calculation. And under certain conditions, such as when a spouse is still living there, it could be totally exempt.
The family home is still totally exempt from the age pension tests, so retaining it can mean lower aged care fees and a higher pension.
Rarely is the funding decision straightforward. It is an emotional time but it is important to consider a range of options both from a financial and practical perspective, says Aged Care Steps technical director Natasha Panagis.
A hasty decision on how to pay the RAD could impact any number of things including the care fees, Centrelink or Department of Veterans Affairs entitlements, cash flow, tax, asset protection and estate planning objectives.
Smart Investor Weekend has identified five funding options, as well as the implications of each, for someone looking to enter residential aged care (or, if they entered aged care before 1 July, 2014, moving to another facility).
1. Sell the family home
With the bulk of people’s wealth tied up in the family home, provided there is no particular reason to keep it, it can be the most obvious asset to sell to fund a RAD.
The issue with this strategy is that there are often surplus funds after the RAD has been paid which need to be invested.
It also means the full value of the house is counted towards the means-tested care fee.
“Putting the money in the bank in the current interest rate environment will probably mean you will go backwards,” says Rachel Lane, Aged Care Gurus principal. “This is because from a Centrelink point of view, once your financial assets exceed $48,600 (for a single person) or $80,600 (for a couple) you are deemed to earn 3.25 per cent – and you probably won’t be if the money is sitting in a low interest-bearing bank account.
“This deemed income is used to calculate pension entitlement under the income test and also the income test for aged care.”
Aged Care Steps Panagis says there are a few strategies available to reduce the value of the surplus amount.
One is to gift the money, although someone on the age pension would be restricted to the gifting rule limit of $10,000 a financial year or $30,000 over five years.
Prepaying a funeral or investing $12,250 in a funeral bond which is an exempt asset could also help, says Panagis.
An insurance bond held within a family trust is another way of reducing assessable income, says Lane.
To use an example, Lane calculates that if someone had $350,000 in the bank after selling their home and paying their RAD, the deemed income of $10,646 a year would reduce their pension by $3217 a year and create a means-tested fee of $1607 a year.
Keeping $150,000 in the bank and investing $200,000 in a bond in a trust would restore the full pension and reduce the means tested fee – a saving of $4854 a year, she says.
Putting money into an annuity, which is not subject to deeming and gives back capital and income over time to help meet cash flow, may be another option.
Lane calculates that someone with $500,000 in the bank after selling their home and paying a RAD could put $450,000 into an aged care annuity rather than leave it in the bank. As a result their pension would increase by $2837 a year and the means-tested care fee would reduce by $4183 a year.
One of few products specific to aged care is Challenger’s CarePlus annuity product.
2. Keep the house, sell down investments
For many people it makes sense to sell the house to pay for the cost of aged care accommodation, preserving other income-producing assets.
For others, keeping the home and selling other assets will be a better approach.
Lane sites an example of a person with a house worth $800,000 and $800,000 in cash/term deposits and who wanted to move into an aged care facility with a market price of $600,000.
If they sell the house to pay the RAD, they will have $1 million invested. They would receive no age pension and their means-tested care fee would be $82 a day for 315 days (until the cap is reached).
On the other hand, if they kept the house and used $595,000 of the investments to put towards the RAD, they would pay a DAP of 85¢ per day, receive $834 a fortnight of age pension and the means-tested care fee would be $39 a day for 365 days.
If the house is rented, the pension would remain the same as the rent is exempt, but it would increase the means-tested care fee at a rate of 50¢ cents per dollar in rent (after expenses).
If investments are sold to pay the RAD and ongoing aged care fees, it is important to reduce the capital gains tax involved and work out the cheapest tax solution, says Freedom Financial Solutions aged care specialist Val Nigol.
3. Equity release
The use of reverse mortgages for aged care purposes is small, says Darren Moffatt, director of reverse mortgage broker Seniors First. But the strategy does exist.
Of the five reverse mortgage lenders, only Bankwest, Heartland Seniors Finance and Macquarie Bank allow reverse mortgage funds to be used to fund aged care accommodation costs. Commonwealth Bank of Australia and St George require the borrower to remain in the house.
The niche proposition that allows people to use the equity in their home without repayment until they die hasn’t deterred La Trobe Financial Asset Management from making its debut in the market with a recently launched Aged Care Loan product. It joins Macquarie Bank with its Accommodation Bond Loan.
The key difference with the La Trobe and Macquarie loan products is that they have loan terms of seven and five years respectively, compared to an open-ended reverse mortgage, although no repayments are made until the resident leaves the facility.
The Aged Care Loan product gives everyone time to think and get over the initial stress of someone moving into care, which is emotionally traumatic, says La Trobe Financial’s head of aged care products Martin Lynch.
He says the loan, available to approved individuals aged over 70 who want to draw on the equity in their home specifically to pay the RAD, means no bridges are burnt and no one in the family is taken advantage of.
“The default position is often to sell the house. But – for a range of reasons, including wanting to keep it in the family, wanting their parents to still be able to visit it or wanting to do it up ahead of sale – often the family needs time. However, faced with the need to pay a deposit to get into the facility they want, they often progress to a financially destructive fire sale,” says Lynch.
“This can be avoided by instead borrowing against the home. This gives [families] breathing space to work out what they want to do and inform the facility as to how [the deposit] will be paid,” he adds.
Features of La Trobe Financial’s loan product include a maximum loan to valuation ratio (LVR) of 50 per cent and loan rate of 5.99 per cent for the first five years, rising to 7.99 per cent in years six and seven.
No interest is payable until the LVR reaches 70 per cent (which would take about five and a half years at current interest rates) and the loan is repaid when the borrower leaves aged care (through death or to return home), the home is sold or the loan term is reached.
The Macquarie Bank Accommodation Bond Loan has a current interest rate of 6.55 per cent. Also available to individuals aged 70 and above, its LVR rises to a maximum of 45 per cent for someone aged above 90.
Because interest compounds on equity release products, debt can escalate quickly. But they have a negative equity guarantee which means you will never owe more than your home is worth.
4. Deduct the DAP from the RAD
A payment option that aged care facilities must offer is the ability to draw down on any deposit made. So if a part refundable accommodation payment, or RAD, is paid, then the resident must be able to pay the outstanding daily accommodation payment from the RAD.
This might suit people who only have part of the RAD, or if full RAD payment resulted in cash flow issues.
Paying as much of a RAD as possible from assets outside the home will avoid having to pay the 6.22 per cent interest rate used to calculate the DAP, but it can impact cash flow, says Aged Care Gurus’ Lane.
“For some people the RAD will be far greater than their assets outside the home and so to ease the cash flow pressure it may be necessary to have the DAP deducted from the RAD,” she says.
This will mean that the total amount in the refundable accommodation deposit will be reduced over time as the daily accommodation payment is deducted.
As the refundable accommodation deposit is reduced, the age care provider may ask the resident to top up the RAD, or pay a higher daily accommodation payment.
Where someone is receiving an age pension or part pension, says Lane, using assets outside the house to pay towards the RAD can increase pension entitlement and reduce the means-tested care fee.
Paying towards the RAD can also ease pressure on cash flow, as the DAP is calculated at 6.22 per cent whereas your investments may only be earning three per cent.
For example, the market price RAD may be $600,000 and you can afford to pay $300,000, leaving a DAP of $51 a day. Instead of paying this from your cash flow, you can elect to have it deducted from your RAD. If you choose this option, your DAP will increase as your RAD balance reduces.
If in the first month the RAD balance is $300,000, then the DAP deducted at the end of the month will be $1555. In the second month the RAD balance will be $298,465 and the DAP deducted will be $1563 and so on.
5. Family pays the RAD
If the choice of room or facility is limited by an individual’s ability to pay the RAD, then family members may step in.
“There is nothing wrong with family paying the RAD to ensure mum or dad get their own room in their preferred facility, but it is best to have a formal loan agreement in place for a number of reasons,” says Panagis.
It may be that one child in the family pays the RAD to ensure a quicker entry before the house is sold. If then the parent repays the child once the house is sold, then Centrelink or DVA will see that money as a gift unless there is a loan agreement in place.
A loan agreement will also help if the RAD is repaid to the estate once the resident dies.
Panagis says that it may be that one child paid the RAD but upon death it is repaid to the estate and will be distributed in accordance with the Will, which may end up divided between several children.
“To protect the people giving the money to pay the RAD, it is best to have a formal agreement,” she says.
Regardless of where it comes from, when it is paid the RAD becomes the aged care resident’s asset, says Lane.
Further, the RAD is an assessable asset for the means-tested care fee. So by paying the RAD, the means-tested care fee will go up but, says Lane, “If you are prepared to take it to the Administrative Appeals Tribunal of Australia, as one family has already done, then it could be that the loan amount is not counted”.
Bina Brown is a director of aged care placement company Third Age Matters.
This article first appeared in The Australian Financial Review