What Retirees Need to Know About 3 High-Cost Financial Products
Retirees are being flooded with offers for high-cost financial products. Here's how to sort through the pile.
Retirement should be a time when you can kick back and smell the roses. But for many retirees, managing savings and benefits is a full-time job, and not an easy job, either. Poor choices could cost you your home, jeopardize your health care, or leave you without enough money to pay the bills in your later years.
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Con artists thrive on confusion, and as we reported last November, seniors are a prime target for financial scams (see Protect Yourself, Loved Ones From Financial Abuse of the Elderly). More than half of all certified financial planners have worked with a senior who has been the victim of unfair, deceptive or abusive practices, according to a recent survey by the Certified Financial Planners Board of Standards. (See ways adult children can help parents spot scams.)
But even legitimate -- and often appropriate -- financial products come with drawbacks that aren't always explained in the marketing pitches. We've focused on three products that are heavily marketed to retirees: reverse mortgages, long-term-care insurance and annuities. Unlike a faulty lawn mower, they can't be returned if you're unhappy with their performance. Before you buy, you need to understand the risks.
What do Robert Wagner, Pat Boone, Fred Thompson and Henry Winkler have in common? If you've watched TV lately, you probably know the answer: They are all celebrity spokesmen for companies that offer reverse mortgages. Once you get over the shock of seeing the Fonz with gray hair, it's hard not to be intrigued. Life without mortgage payments! A government-insured loan! The retirement you deserve!
Like a traditional mortgage, a reverse mortgage allows you to borrow against your home equity. You don't have to repay the loan as long as you remain in your home. You must be 62 or older to qualify, and your home must be your primary residence. If you need extra income to supplement your retirement savings, a reverse mortgage may seem like the answer to your prayers. But the TV ads don't say much about the downsides.
You could run out of money. You can take your payout as a line of credit, monthly payments or a lump sum. In recent years, the majority of borrowers have opted for a lump sum, according to a recent report from the Consumer Financial Protection Bureau.
Peter Bell, president of the National Reverse Mortgage Lenders Association, says there's no evidence that lump-sum borrowers are spending the money frivolously. Many younger borrowers are using reverse mortgages to pay off their existing mortgages, which frees up money for other purposes, says Bell. But borrowers who withdraw all of their available home equity upfront "will have fewer resources to draw upon to pay for everyday and major expenses later in life," the CFPB says.
And the younger borrowers are when they tap their home equity, the greater the risk they'll run out of money. According to the CFPB report, in 2011, nearly half of borrowers were in their sixties; in 1990, less than 20% were.
Reverse mortgages are expensive. Although fees have come down, reverse mortgages are still a costly source of cash. The most common reverse mortgage, the federally insured Home Equity Conversion Mortgage (HECM), charges an initial 2% insurance premium on the full value of the home, which guarantees that you will receive expected loan advances. That means you would pay a premium of $8,000 on a home valued at $400,000, no matter how much you borrow. Lenders that offer HECM loans are also allowed to charge an origination fee ranging from $2,500 to $6,000, depending on the appraised value of your home. And you'll pay closing costs that typically include an appraisal, title search and other fees, along with servicing fees of up to $35 a month.
The HECM Saver, available since 2010, charges an initial insurance premium of just 0.01% of the home's value. However, the amount you can borrow is much lower than it is for the standard HECM, and the interest rate is higher.
Because fees are so high, you should explore other sources of funds before taking out a reverse mortgage, says Susanna Montezemolo, vice-president of federal affairs for the Center for Responsible Lending, in Washington, D.C. A traditional cash-out refinancing or home equity line of credit is less costly, although retirees who are living on a fixed income may have trouble meeting post-2008 lending standards. Tapping your savings is another alternative. "I know some people are loath to go into retirement savings, but their home is their savings as well," Montezemolo says.
You could lose your home. Even though you don't have to make payments on a reverse mortgage, you're still responsible for homeowners insurance, property taxes and maintenance. As of last February, more than 9% of reverse-mortgage borrowers were at risk of foreclosure because they had fallen behind on tax and insurance bills, reports the CFPB.
Another problem: Because the amount you're eligible to borrow is based on your age or, for married couples, the age of the younger spouse, some couples remove the younger spouse from the deed to the home before applying for a reverse mortgage. If the spouse whose name is on the deed dies or moves into a nursing home, the loan will come due, forcing the younger spouse to pay off the loan or sell the house.
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Because of the cost and complexity of reverse mortgages, the Department of Housing and Urban Development requires that you obtain counseling from a government-approved agency. You can find a counselor in your area by calling 800-569-4287 or visiting www.hud.gov/counseling.
Even seniors who are happy with their reverse mortgages say the application process is a lot more complicated than the ads let on. David Bishop, 69, of Mystic, Conn., says his application was rejected by three banks after their appraisers found minor problems with his waterfront property. The third bank referred Bishop to a reverse-mortgage specialist, who helped him qualify. Bishop plans to downsize to a smaller home eventually, but the line of credit he received from his reverse mortgage will allow him to stay in his current home a few more years. "I'm glad I'm not a frail senior in my seventies or eighties, as this experience would have probably given me a heart attack," he says.
To hear some insurance agents tell it, everyone older than 55 should have long-term-care insurance. The argument they make is compelling: The median cost for a private room in a nursing home is more than $81,000 a year. Medicare doesn't cover most nursing-home care, and Medicaid won't kick in until you've exhausted most of your assets.
A comprehensive long-term-care policy is the best defense against the cost of a catastrophic illness and will preserve assets you want to leave to your children. But you won't enjoy those benefits if you can't afford the premiums. The average annual long-term-care insurance premium for a 60-year-old couple in good health is $3,335 for $340,000 in coverage, according to the American Association for Long-Term Care Insurance. What your agent may not tell you:
The cost of premiums could jump. Faced with a higher-than-expected number of claims, several major insurers have asked state regulators for permission to increase rates by 40% or more. Additional rate hikes are likely as thousands of baby-boomers who already have policies start filing claims, says Steve Robbins, a certified financial planner in St. Louis.
If a premium hike forces you to let the policy lapse, you'll lose your entire investment. There are ways to avoid that, says Jesse Slome, executive director of the AALTCI. If your policy provides unlimited coverage, you can avoid a rate hike by reducing the coverage to three or four years, which Slome says is sufficient for the majority of seniors. Reducing the annual inflation adjustment from 5% to 3% will also lower your premium.
You may not need long-term care. You're less likely to end up in a nursing home if you're married. Even if you do need long-term care, the cost is likely to be contained: The median stay in a long-term-care facility is 463 days, according to the Centers for Disease Control and Prevention.
If you invested the annual premium for a 60-year-old couple of $3,335 for 25 years and earned a 4% annual rate of return, you'd have about $153,000. If you don't need long-term care, the money can be used for other purposes.
The drawback to self-insurance is that your savings may not be sufficient to cover the cost of a chronic illness. In 2011, 10% of long-term-care insurance claims were for individuals under age 70, according to the AALTCI. Some of those individuals will require nursing-home care for a decade or more.
There's a huge variation in price for the same level of coverage. If you decide to buy long-term-care insurance, make sure you work with an experienced agent who is authorized to sell policies from more than one insurer. Otherwise, "depending on your age, you could pay almost double for basically the exact same coverage," Slome says. (To find an agent, contact the AALTCI at 818-597-3227 or www.aaltci.org.)
In addition, someone who only occasionally sells long-term-care insurance may be unfamiliar with features developed in the past three or four years to make coverage more affordable. For example, married couples can save money with a shared-care policy, which allows them to pool their benefits.
Seniors are often bombarded with pitches for annuities, and there's a reason for that: Annuities can be extremely profitable for the agent who sells them. That's particularly true of variable and deferred annuities, which are often riddled with complex terms and high fees. In fact, variable and equity-indexed annuities are by far the most common products associated with unfair and deceptive sales practices targeted at seniors, the CFP Board of Standards says.
Immediate annuities are more straightforward, and thus less popular with shady operators. When compared with variable annuities, immediate annuities are "less prone to abuse and generally much more stripped of costs," says Michael Kitces, a certified financial planner in Columbia, Md. (see Real Money).
But even immediate annuities can be overhyped. Consider these caveats:
You give up control of your money. When you buy an immediate annuity, you hand over a lump sum to an insurance company in exchange for a monthly payment for the rest of your life (or in some instances, a specific period). For that reason, even the most outspoken supporters of immediate annuities advise against investing all -- or even most -- of your savings.
Inflation could erode your payouts. Henry "Bud" Hebeler, a former Boeing executive and author of the book Getting Started in a Financially Secure Retirement, retired from Boeing in 1989 with a pension that pays out the same amount every month. During the first ten years of Hebeler's retirement, his monthly payments lost 30% of their purchasing power, and those were years of relatively low inflation.
If you expect to take payments for more than ten years, Hebeler says, you should buy an annuity that's adjusted for inflation. Your initial payouts will be lower, but you'll protect yourself against a surge in prices. Some immediate annuities provide an annual increase in your payments of between 1% and 5%; others tie payments to annual increases in the consumer price index. In exchange for this protection, your initial payments will be 25% to 30% lower than you'd get from an annuity that doesn't adjust for inflation.
Low interest rates reduce your income. Insurers invest proceeds from annuity investors in the bond market. If interest rates -- and insurance company earnings -- are low when you buy an annuity (as they are now), the size of your promised payouts is stunted. That doesn't mean you should put off buying an annuity, because interest rates could remain low for a long time, says Roger Ferguson, chief executive officer of TIAA-CREF. A better strategy, says Ferguson, is to invest your money gradually. Laddering your annuity purchases will allow you to lock in higher payments if rates rise. Plus, as you get older, the amount of your payout will increase to reflect your shorter life expectancy.
Once you've decided how much you want to invest, you can go to a Web site such as www.immediateannuities.com and compare insurers' payouts.
If the insurance company goes under, your money may be lost. A lifetime payout is only as good as the company behind it, so make sure you buy from an insurer rated at least A+ by A.M. Best. You can check out an insurer's rating at www.ambest.com. (See more tips on buying an immediate annuity).
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