Life annuities vs. RADs: the battle for a fairer, simpler retirement

Refundable Accommodation Deposits (RADs) may hinder the adoption of a better retirement model in the form of life annuities, writes UNSW Business School's Anthony Asher

I am researching the obstacles to developing a life annuity market in Australia. One of my findings is that how we fund aged care discourages life annuities. This is because those who keep their capital to pay a lump sum upfront for their accommodation get overgenerous subsidies. These RADs (Refundable Accommodation Deposits) average some $500,000 and roughly represent the cost of building the room you will occupy.

The government is considering how much superannuation can be used to fund aged care. The aged care industry thinks it should. Eliminating overgenerous subsidies would help.

The position can be summarised as follows. If retirees were to buy life annuities with their superannuation balances, they would spend their capital over their lifetimes. Retirees do not want to spend their capital partly because the aged care system rewards them for keeping it. Therefore, they do not buy life annuities and pay less for aged care.

To illustrate, consider a recent letter published in a newspaper: “My husband and I received a part pension, but he passed away and I now have all the assets but no pension. I am 88 and own my own home. I have $680,000 in savings and $180,000 in shares. My income is $25,000 per annum Is there anything I can do to get a part pension?”

The general advice given in response was: “A major factor to be considered when drawing up a will is what effect a legacy could have on a beneficiary. As you have learnt, a widow can lose her pension if all the money was left to her instead of being judiciously spread among family members. Just keep in mind that the full pension for a single homeowner is $28,000 a year, and your portfolio is already giving you almost as much and will almost certainly grow. An aged pension appears out of the question, but you would certainly qualify for a Commonwealth Seniors Health Card.”

Read more: Is it time for the last great superannuation reform?

My first thought was that it would have been better to give the following response (which you should not take as financial advice). “You could significantly increase your spending if you invested your savings in a life annuity. The guaranteed, inflation-linked annuity rate for an 88-year-old woman is approximately 12.5 per cent. Your savings would generate an annual income of $85,000, and you would still have your dividends and your shares as a contingency fund. A life annuity would not be appropriate if you are in poor health, and you will probably have to consult a financial planner to buy one. The planner would discuss the implications if you need to go into aged care. You might also discuss these issues with your children. If you only spend $25,000 per annum, you are living well below what you could easily spend. If you do not want to spend $85,000, consider the pleasure you could get from giving to family and charities."

The financial planners I spoke to were not that impressed. Their main concerns were the children and the ability to pay a RAD.

My view about children is that they are already likely to inherit the house but are probably cash-strapped – especially if suffering from high interest rates. They’ll get the value of the house when their mother dies. If she is in good health, they could be better off if they spread their risks and ask her to give them the extra money from the annuity.

The RAD is more complicated. $500,000 is a terrifying amount for many people. The good news is that you can pay a DAP (Daily Accommodation Payment) instead – for all or part of the RAD. The bad news, however, is that the DAP depends on the MPIR (Maximum Permissible Interest Rate), which is currently 8.38 per cent. To stick with our widow’s circumstances, let’s assume that she might pay a RAD of $680,000 or a DAP of $56,948 per annum. She would also have to pay the basic living costs and a means-tested fee for care, with the government paying the balance. The formulae they use are horribly complicated, but fortunately, there is a great government website that allows you to work it out.

So let us consider our widow’s finances if she has to go into aged care and does not want to sell her house.

Option 1 is to use her $680,000 in savings as a RAD and pay no DAP. From the website, she will have to pay a basic daily fee plus a means-tested care fee of $36,266. No worries, because she now qualifies for the full-age pension (because the RAD does not count as an asset). The age pension plus say $9000 per annum in dividends should leave her with some change.

Option 2 is to buy an annuity with her $680,000, giving her an income of $85,000 out of which she must pay $56,948 for the DAP and then an increased amount of $51,848 for the Basic daily fee plus means-tested care fee. Even with her dividends, this leaves her about $14,000 per annum out of pocket. She would have to pay it from her share capital.

The financial planners, therefore, have a point when they recommend that people keep cash available for the RAD.

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If people have to go into aged care, they are better off while they are there, but the government – and taxpayers – are therefore worse off. In option 1, the government is paying the age pension of $28,514 and recovering $15,500 less from the means-tested care fee ($44,000 per annum more than option 2). The RAD’s exemption from the age pension means test is the main issue, but it also seems that the means test formula penalises income at the expense of assets.

That is not all. The volatility of the MPIR creates considerable uncertainty. At the lowest point of the MPIR in 2021, option 2 would be about $16,000 better than option 1. At the highest level of MPIR in 2008, option 1 would be $33,000 per annum better. So, accommodation costs to residents and the revenue of the aged care homes are a lottery. The homes would have a much more stable income base if they could raise long-term finances at a fixed real rate. Their financial structure often makes this difficult. Given that the government currently guarantees the repayment of the RAD, it could reasonably think of guaranteeing equivalent long-term finance. The superannuation funds might be enthusiastic investors.

StewartBrown provides perhaps the most authoritative analyses of aged care financing, and they recommend abolishing the RADs. Their view is that the RADs are “cumbersome and confusing” and “inequitable for consumers and providers.” If we also want retirees to buy life annuities that will enable them to enjoy a higher standard of living in retirement, the RADs must be ditched.

Anthony Asher is an Associate Professor in the School of Risk & Actuarial Studies at UNSW Business School. He is active in the actuarial profession and is involved in research and policy development. He is also a Board member of Fresh Hope Communities, but this article has been produced independently and does not necessarily reflect the views of Fresh Hope Communities. For more information, please contact A/Prof. Asher directly.