While in the mortgage business in Overland Park, Kan., I personally originated a dozen reverse mortgage loans. Eleven of them solved an immediate cash-flow crisis for the client, while one was used for long-term planning.
That one was recommended by a savvy financial planner, and friend of mine, who recognized his client was outspending his investments. He was on the road to a financial disaster 15 to 20 years later. Our planning and execution of a comprehensive plan that incorporated home equity into his funding stream made it possible for this client to continue to live and pursue his retirement goals. Had my friend ignored home equity like a blindspot, as so many planners do, his client would have needed to make dramatic changes to his financial plan and lifestyle. It was an important lesson that I carry with me today as a planner myself.
The utilization of a reverse mortgage adds more liquidity to a client’s financial plan by unlocking home equity to create tax-free cash flow. Incorporating a reverse mortgage and coordinating spending from home equity throughout retirement offers a way to meet spending goals and provide a larger legacy. It can solve a multitude of planning problems and make it possible for investments to continue to grow. Rather than wait until the last minute to factor housing wealth into a funding equation, I always consider whether the following strategic uses of a Home Equity Conversion Mortgage (HECM), aka reverse mortgage, could benefit my clients who are 62 and older.
Delay The Start Of Social Security
Your client wants to start claiming Social Security at full retirement age of 66, but you believe it is in their best interest to wait until 70 and receive the higher amount. The delay creates a $2,000/month shortage for four years, or an unfunded liability in the range of $80k-$100k depending on your client’s income tax bracket. How will you fund the shortage?
Consider using the proceeds from a HECM loan. Using this online calculator, you will see that a 66-year-old whose home value is $200,000 would be able to access about $102,000 in home equity with an adjustable rate reverse mortgage; enough to replace the cash flow Social Security would have provided between age 66 and 70.
If delaying Social Security results in an increase of $10,000/year, this would be the equivalent of the client having access to another $250,000 to safely withdraw from for the rest of his/her life. Using the reverse mortgage in this context is financial leverage and mitigates the risk of outliving retirement funds even after you factor in the loan’s costs.
The delay strategy also gives your client time to either spend down IRA investments or convert to ROTH. Both help to avoid the possibility of the “tax torpedo” coming from higher taxes on Social Security due to higher MAGI.
Buy A New Home
Your clients want to move out of the old two-story, $250,000 home and “right-size” into a house that will provide more safety and accessibility as they age. Here in the Kansas City metro area, $400k-$500k is the approximate price for a single-level property that would include multiple other long-term care and community-type benefits.
They want to pay all cash for their new home by combining sale proceeds from the old house with money from their portfolio. You are concerned about the tax consequences to your clients if they liquidate investments, but you don’t want them saddled with a monthly mortgage payment either. How do you reconcile this?
Consider using a reverse mortgage to buy the new home. For homebuyers 62 and older who can make a sizeable down payment, HECM for Purchase can be used to finance the rest of the deal, and unlike a conventional mortgage, it will not require monthly principal and interest payments.
Using a reverse mortgage for purchase is another strategy that creates leverage and can make it possible to leave more investments in the market and ultimately available for beneficiaries.
Give More To Beneficiaries
Your client’s beneficiaries are in a higher tax bracket than your client and everyone wants to avoid income in respect of a decedent taxation down the line. You want to develop a strategy that converts all IRA funds to Roth IRAs between the ages of 62 to 70, but need a source of funds to cover the taxes while maintaining a low tax bracket.
Consider using a reverse mortgage line of credit. Adjustable rate HECM loans can be used to create a line of credit, similar to a HELOC, that does not require a monthly principal or interest payment.
With a reverse mortgage line of credit, a borrower has the option to withdraw funds and then repay the loan balance at any time without penalty. The flexibility makes this an ideal way to pay taxes on the IRA withdrawals that you’ll make before moving those into a tax advantaged Roth IRA. Working collaboratively with your client’s CPA/tax preparer will give you confidence of exactly how much IRA to convert to Roth each year.
Because reverse mortgage loan proceeds are non-taxable, these funds won’t push your client into a higher tax bracket. Another benefit of using a HECM is that the unused portion of the line of credit actually grows over time at the same rate as the loan balance. Retirement researcher Wade Pfau of the American College explains this well in an article for the Journal of Financial Planning:
“When funds are borrowed, the line of credit decreases and the loan balance increases. Conversely, voluntary repayments increase the amount of the line of credit, which will then continue to grow at the effective rate, allowing for access to more line of credit later on.”
For beneficiaries, legacy wealth is the remaining value of financial assets plus any remaining home equity after repaying the reverse mortgage, which is a non-recourse loan. Since money is fungible, the specific ratio of financial assets and remaining home equity is not important. Preservation of home equity is merely a psychological constraint and, like most negative investor behaviors, will lead to a less efficient retirement.
The National Reverse Mortgage Lenders Association’s website includes resources explaining how the loans work, how they can be used and how they are repaid.
It’s our job as professionals to make sure strategic uses of home equity are not a blindspot for our clients. We are going to see a rise in the number of Americans needing to use home equity in their golden years of retirement. Will you proactively learn about home equity strategies or wait until your client asks you a question you’re not prepared to answer?
Brendon Jenks is the owner of two registered investment advisory firms, Wealth Renovators and Stewardship Wealth Management in Overland Park, Kan.