Tag Archives: Retirement

Reverse Mortgages Enter Financial Planning Mainstream

25 Apr

This month has seen a number of articles discussing reverse mortgages as a viable option for older Americans looking to supplement their retirement income.  The authors often admit that they were at first suspicious, even outright negative towards the product, and are now surprised to confess how useful they can be.

Long thought of as something retirees used in last-ditch efforts to stay in their houses, they were seen more as leaky lifeboats than as financial planning tools. They were badges for people soon to be broke.  Reverse mortgages were great examples of too little, too late.

But all that may be changing.

If a recent Journal of Financial Planning paper gets traction, the use of reverse mortgages will move from people who are desperate to practical people who have both home equity and some financial assets.

This will happen for a totally unexpected reason: if reverse mortgages are used early, rather than late, they can be as important in the retirement planning toolbox as life annuities.

A 4 percent guideline

Rather than wait until all financial assets were exhausted and then taking out a reverse mortgage, Barry Sacks, a San Francisco tax attorney and Stephen Sacks, Professor Emeritus at the University of Connecticut asked how things would turn out if retirees took out a reverse mortgage first or early. This would allow them to use withdrawals from the reverse mortgage to delay or reduce withdrawals from financial assets.

None of this matters, they found, if the retirement income withdrawal rate was set at an initial 4 percent, with the amount adjusted upward for inflation in each succeeding year. In that case, there was a 90 percent chance that investment money alone would last through 30 years of retirement.

Things change, however, when you up the withdrawal rate, as many retirees need to do. When the withdrawal rate is increased, they found that using a reverse mortgage increased the odds of remaining solvent throughout life.

Taking a 6 percent withdrawal rate and using a reverse mortgage first or early, for instance, provided an 80 percent probability of “cash flow survival” for 30 years, while using a reverse mortgage last provided only a 50 percent probability of cash flow survival.

Similarly, taking a 6.5 percent withdrawal rate and using a reverse mortgage first or early provided a 70 percent probability of cash flow survival for 30 years, while using a reverse mortgage last provided only a 40 percent probability of cash flow survival.

This enormous increase in retirement income seldom comes at the expense of net estate value. In a majority of cases, they found net worth at the end of 30 years (remaining home equity and remaining retirement assets value) was greater as often as three-fourths of the time. In other words, you can eat cake and still pass some on to your kids or favorite charity, too.