Until recently, the subject of reverse mortgages rarely ever came up in my consultations with clients. When it was discussed, it was the client who brought it up. I'd easily dismiss the idea of a reverse mortgage because it was an expensive form of borrowing and posed unnecessary risk when there were other sources of income. Besides, tapping home equity through a reverse mortgage was always viewed as source of last resort for retirees who had insufficient capital to meet their income needs.
I've since reconsidered my bias against reverse mortgages and now view them as a viable tool in the context of a holistic retirement income plan in certain situations. Here's why:
- First, recent rule changes by the Federal Housing Administration (FHA) have reduced borrowing costs and lowered the risk to borrowers. It is still a more expensive form of borrowing, but not prohibitively so.
- Second, considering the risks facing all retirees who rely on their own capital as a source of lifetime income—sequence of returns, longevity, inflation—it would be foolish not to consider one of their largest stores of wealth, their home, as part of their retirement income plan, even if it was never needed.
- Finally, a significant body of research now shows that responsible use of a reverse mortgage can increase both the sustainable withdrawal rate and the net legacy available for heirs.
Reviewing the Basics
The basic structure of a reverse mortgage allows homeowners over the age of 62 to borrow the equity from their home up to a certain limit based on the borrower's age, the interest rate and the amount of equity in the home. The amount borrowed, either through a lump sum or monthly payments, is paid back to the lender when the youngest homeowner sells, dies or leaves the property permanently for any reason. The money received is tax-free, and the accrued interest is tax-deductible (up to applicable deduction limit) upon repayment.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The Reverse Mortgage LOC as a Planning Tool
Another way to access the equity is through a reverse mortgage line-of-credit (LOC). As with any LOC, it can be established and accessed anytime funds are needed. Unlike a traditional LOC, the credit limit of a reverse mortgage LOC actually increases each year. The longer it is not used, the more cash becomes available. Adjustable rate mortgage (ARM) loans can be drawn and repaid indefinitely, and any funds repaid can be used in the future and will again have the growth factor applied. For fixed-rate loans, they can be repaid, but no additional funds will be available (closed-end loan). It's these unique properties of the reverse mortgage LOC that offer retirees more planning options that can help protect their assets and improve their quality of life.
Avoid Sequence of Returns Risk
One of the biggest risks retirees face when converting their capital into income is the sequence of returns. If there is an expectation that a retiree can withdraw a certain percentage of their capital each year without the risk of outliving their income, a prolonged stock market decline early in retirement could require that percentage to be reduced or selling stocks at a loss to make up the difference. With a reverse mortgage LOC, retirees can tap their equity at a cost of 3% to 5% interest, rather than selling stocks at 10% to 30% loss. When stock prices recover, some can be sold to repay the LOC. In this way, a reverse mortgage LOC can be the best tool to use to ensure the sustainability of a retirement portfolio.
Delay Social Security Benefits
For some retirees, delaying Social Security benefits to age 70 is the recommended course if they want to maximize their benefits. Each year benefits are deferred past age 65, the benefit increases 8%. However, if income is needed before age 70, retirees can use their reverse mortgage LOC, which charges a rate of 4% to 5% (and doesn't have to be repaid), to meet their income needs. If there is money available when Social Security benefits commence, it can be used to replenish the LOC.
Convert to a Roth IRA
For many retirees, receiving taxable income from a 401(k) or a traditional IRA can present problems when it lifts them into a higher tax bracket and subjects a larger portion of their Social Security benefits to taxation. These plans also create potential issues because they are subject to required minimum distributions (RMD) starting at age 70½.
A reverse mortgage can help address both problems. Retirees can use their home equity to convert their 401(k) and traditional IRA plans into a Roth IRA.
When converting to a Roth, the distributions from a 401(k) or traditional IRA become taxable, which must be paid at the time of conversion. The home equity can be used to pay the tax, and from that point forward, any distributions from the Roth are tax-free. In addition, income from a Roth IRA is not included in the Social Security tax calculation. The reverse mortgage LOC would be the preferred option because it can be used only as needed and replenished with any excess cash flow.
Paying for Long Term Care Costs
Long-term care insurance is a great way for retirees to shift risk for potential care costs and preserve assets for heirs, but many shy away because the premiums can be high and increase in the future. The reverse mortgage LOC can be a resourceful way to help pay long-term-care insurance premiums without impacting retirement cash flow. Since the credit line is guaranteed to grow over time, it can offset LTC insurance premiums if they rise. For retirees that choose not to insure or don't qualify for insurance, the reverse mortgage LOC can be used to directly cover the costs of home care or a spouse's facility care.
When considered in the context of a holistic retirement income plan, it should be considered with the guidance of an independent financial adviser specializing in retirement income planning.
Woodring is founding partner of San Francisco Bay area Cypress Partners, a fee-only wealth consulting practice that provides personalized, comprehensive services that help retirees and busy professionals to enjoy life free of financial concern.
Craig Slayen, a new partner with Cypress Partners, contributed to this article.
-
Ten Retirement Tax Plan Moves to Make Before December 31Retirement Taxes Proactively reviewing your health coverage, RMDs, and IRAs can lower retirement taxes in 2025 and 2026. Here’s how.
-
The Best (and Worst) Airlines for Flight Delays and CancellationsWhich airlines should you book and which should you avoid if you want to make it to your destination on time?
-
I'm a Financial Planner: This Is Why Commitment, Not Perfection, Drives Financial SuccessMeeting your goals is more likely if you stick to your strategy despite market volatility and scary headlines. Consistency makes a difference.
-
Four Ways to Make the Most of Your Benefits During Open EnrollmentOpen enrollment is a chance to make sure you're getting every ounce of value from your workplace benefits and on track to reach your long-term financial goals.
-
A Nightmare for Parents: How to Navigate the Legal Boundaries of Tenant Rights During a Family CrisisThis family's story illustrates how important it is to get help sooner rather than later and highlights the complexities of tenant rights and legal protections.
-
Eight Steps to Help Get You Through the Open Enrollment Jungle at WorkWondering how to survive open enrollment this year? Arm yourself with these tools to cut through the process and get the best workplace benefits for you.
-
Seven Moves for High-Net-Worth People to Make Before End of 2025, From a Financial PlannerIt's time to focus on how they can potentially reduce their taxes, align their finances with family goals and build their financial confidence for the new year.
-
A Compelling Case for Why Property Investing Reigns Supreme, From a Real Estate Investing ProInvestment data show real estate's superior risk-adjusted returns and unprecedented tax advantages through strategies like 1031 exchanges and opportunity zones.
-
Government Shutdown Freezes National Flood Insurance Program: What Homeowners and Buyers Need to KnowFEMA's National Flood Insurance Program is unavailable for new customers, increased coverage or renewals during the government shutdown.
-
This Is Why Judge Judy Says Details Are Important in Contracts: This Contract Had HolesA couple's disastrous experience with reclaimed wood flooring led to safety hazards and a lesson in the critical importance of detailed contracts.
