Retiring with debt? Experts explain downsizing, using super for your mortgage, and pension eligibility

This article is part of The Conversation’s “Retirement” series where experts examine issues including how much money we need to retire, retiring with debt, the psychological impact of retiring and the benefits of getting financial advice.

About 36% of homeowners still have a mortgage when they retire, up from 23% a decade ago.

This increase in mortgage debt is due to soaring property prices, changes in retirement ages and easy access to drawdown equity loans (where you use your home as security to get a loan, which can be used to fund travel, medical costs and other expenses).

So, what are the options for homeowners who carry debt into retirement?

Option 1: keeping the home and the debt

If you keep the family home in retirement, you get to own a property and can still receive the age pension.

For example: Jackie has a home worth A$2 million with a $200,000 mortgage. She also has $800,000 in superannuation. She is 67 but is not eligible for the age pension because her assessable assets – her super – is above the $695,500 cut off.

If Jackie takes $200,000 from her super and repays the outstanding mortgage debt, she will save on interest and principal repayments for the next ten years. She will also reduce her assessable assets by $200,000. This makes her eligible for a part pension.

So while Jackie has less super, she gets to receive a pension and gets all the subsidies associated with being a pensioner.

Option 2: downsizing to clear the debt

Downsizing can extinguish any remaining debt, and can free up money for holidays, restaurants and the good life in retirement. It also enables a move to a more age-friendly home or apartment.

And the government does provide a superannuation incentive via the downsizing contribution.

This allows homeowners over 55 who have lived in their home for more than ten years to make a one-off contribution of $300,000 (singles) and $600,000 (couples) to their super, using money from the sale of their home.

But when a person reaches pension age, currently 67, any money in super will be included in the government’s assessment of your financial assets and income. It could mean you don’t qualify for a pension or pensioner subsidies.

Of the approximately 2.6 million who receive a part or full the age pension, only 78,000 people have taken up this initiative. That begs the question if this option really does create a true financial downsizing incentive.

Think again of Jackie, the woman with the $2 million home and the $200,000 in mortgage debt. Say she decides to sell her home and move to a smaller house close to family and friends. This will incur about $40,000 in selling and marketing fees, and stamp duty of around $62,000 on her new $1.4 million apartment.

Downsizing leaves her with $1.1 million in financial assets (after transaction costs), which means that Jackie is not eligible for the pension.

While she’ll be able to fund a comfortable lifestyle, this decision to downsize may not be as attractive as keeping the house.

The decision to sell and move has cost her an extra $100,000 in transaction costs and her pension.

So, people need to think carefully about downsizing. It can allow people to move closer to children, grandchildren, and the services they need – but these must be balanced against the financial implications.