Ok
so you and your family have finally made the decision to sell your home and move
on, now what? Are you aware of all the options available to you? Will you
consider moving in with an adult son or daughter who can help you with your
needs as you grow older? Or perhaps you are considering moving to a senior
supportive environment.
Many
seniors would prefer to continue living in their own home, aging in place.
Sometimes circumstances work against those preferences. Whatever the reason,
there may come a time when parents, along with their adult children consider
selling and moving on.
Unique issues and complex decisions
Selling a senior’s home really is different and can be much more complicated.
You will most likely be dealing with several unique issues and complex
decisions during the process. Though seniors usually make the decision to sell,
it is not uncommon for their adult children to be involved in the process.
See your house as an investment
Once the decision to sell has been made you need to start looking at the home
as an investment. That involves selling the home for the most money, in the
shortest time and with the least amount of inconvenience.
For
most people a home represents the largest part of their net worth so getting
the maximum price for the home is of utmost importance. Many seniors will be
living on a fixed income; therefore the equity in their home becomes an
integral part of their overall financial plan.
Put together an action plan to effectively
market your property for top dollar.
Consult with a Seniors Real Estate Specialist
The issues facing senior citizens when selling their home are much different
than for younger people, and most real estate agents have little idea how to
resolve them. A mistake can be very costly, and for that reason any senior
looking to sell their home should consult with a specialist. This professional
should maintain a network of other senior-focused professionals who can assist
in tax counseling, financial and estate planning, and other aspects of the sale
and move.
Create a marketing plan
Once you have selected an agent that you feel confident about and are
comfortable working with, it is now time to put together a marketing plan for
the home.
Comparative Market Analysis
The first step is to have your agent prepare a CMA (comparative market
analysis). This is a key piece of information as it compares your
property—the subject property—with other homes in the area known as the
comparables.
The
CMA will compare your home against other homes that have sold in the last 90
days, are currently listed for sale or that did not sell in the last 90 days
where the listing has expired and terminated.
Determine your listing price
Once the agent evaluates the information and makes the necessary adjustments to
make the subject property as close to the comparables as possible, it is time
to determine a listing price for the property.
Under pricing and over pricing
Many seniors, once they decide to make the move, often make the mistake of
“under pricing” the property in order to secure a fast sale. This is not
recommended and should be discouraged.
In
order to sell the property for maximum dollar, caution must also be taken not
to “over price” the property either. This is also a very dangerous strategy as
it will assist in selling other properties in the area.
Pricing and Buyers
Pricing a property within the recommended range will bring in around 75-80
percent of prospective buyers. Even in a hot market pricing the property too
far above market value will limit showings as only 5-10 percent of all eligible
home buyers will see the home. Listing the home below market value will
guaranty that 100% of potential home buyers will see the home but again this is
a very dangerous area. The public will perceive this to be a bargain which
could result in the seller getting far less than what the home is worth.
Selecting a proper listing price is one of the most important factors when
selling a home.
Seller’s market or buyer’s market?
During the listing of your home your agent should have discussed the current
market conditions presently being experienced in your area. You should have a
general understanding of how the local real estate market works, along with the
forces and influences affecting your local real estate market at the present
time.
Questions
like whether it is a seller’s or buyer’s market should be answered. Perhaps the
market is more balanced. If so, your agent should be able to tell you what
effect this will have on the price and the average number of days it takes to
sell a home like yours.
Listing on MLS
Another important factor when marketing the home is to list the property on
MLS. The multiple listing service is a very important tool to help gain maximum
exposure because it markets the property to all the other realtors who are
members of the real estate board. It also gives the public access through the
public MLS site that is supported by the real estate board and its members.
WASHINGTON – Nov. 7, 2011 – Do you know that if you are 62
years or older you may be able to buy a house or a condominium using a reverse
mortgage? A reverse mortgage allows you to get money from a lender, but you do
not have to pay it back (or make any monthly payments) until you sell or die.
How does it work? Let’s assume you just sold your existing
house and want to downsize to a smaller house or a condominium unit. You have
$300,000 cash from the sale, and since you qualified for the up-to-$500,000
exclusion of gain, you will not have to pay any capital gains tax.
Your new property will cost approximately $300,000. You are
retired and do not have a current, steady stream of income other than your
modest retirement fund. You might be able to get a traditional mortgage but you
will probably have to come up with a large deposit – maybe as high as 30
percent of the sale price.
This will significantly drain your finances and affect your
current lifestyle. What about a reverse mortgage?
You could consider the FHA Home Equity Conversion Mortgage,
which is the only federally insured reverse mortgage available.
To qualify, you must be at least 62; if you are buying with
a spouse, both of you must meet the age requirement. The house you buy must be
your principal residence and you must certify that you will live in the house
within 60 days of obtaining the loan. Although single-family residences and
properties with two to four units are eligible, cooperative housing is not. And
if you are considering buying a condominium unit, make sure that the entire
condominium association is FHA-certified.
You (and your spouse, if applicable) will be required to
meet with an approved credit counselor because there are significant legal and
financial implications to such a mortgage. If you plan to leave your house to
your children, for example, a reverse mortgage may leave little or no equity
should you live a long time. Additionally, there are costs involved in such a
transaction, although in many instances, they can be included in the amount of
the loan. A counseling certificate must be submitted to the lender before
closing.
You must use your own cash for the difference between the
amount of the reverse mortgage and the sale price. Sellers can pay such costs
as transfer tax, real estate commission, title search and other fees typically
paid by a seller, but seller credits or set-asides for repairs will not be
permitted.
How much will you be able to get by way of the reverse mortgage?
That depends on a number of factors, primarily the age of the youngest
borrower, the interest rate, the ZIP code and whichever is lower – the actual
sales price or the appraisal. Why ZIP code? Because there is a maximum claim
amount, which is linked to the FHA loan limit on single-family dwellings. That
limit varies by state, county and even city. For example, in the District of
Columbia, Arlington, Alexandria, Bethesda and Gaithersburg, the current limit
is $625,500. In other areas, it ranges from $271,050 to $494,500.
Several online sites have very helpful loan calculators that
will assist you in determining how much money you will need. I took our
example, and plugged in a D.C. ZIP code and the ages of husband and wife in the
mid-70s. According to the calculator, I was able to get a reverse loan of
$198,187 for a standard, fixed-rate reverse mortgage. That means I will need a
little over $100,000 to buy that $300,000 property.
Is a reverse more favorable than a regular mortgage? Yes,
for two reasons: First, I will still have almost $200,000 left from the earlier
sales proceeds. But more important, I will not have to make any mortgage
payments. The bulk of a regular mortgage payment is the portion that goes to
interest. For example, if I were to get a 30-year fixed loan for $200,000 at
4.25 per cent, my monthly payment would be $975 – money I am saving with the
new reverse loan.
When does the loan come due? When you move out or die. At
that time, you or your estate will either have to pay off the then outstanding
mortgage – which will be much higher than the original loan, since interest
will be added yearly – or sell the property. But one thing is clear: Neither
you nor your heirs will ever have to pay more than the value of the house;
that’s what FHA guarantees, since it has to pay any excess.
Need more information: George Lagarde GLagarde@AllWestern.com ReverseMortgageLV.com
Reverse Mortgage Industry: We Have a Financial Planner Problem
After
speaking with several financial planners for a recent article on RMD, it became
clear the industry faces a serious problem… Financial planners have little to
no knowledge about reverse mortgages. When
asked if they had recommended—or would ever recommend—one of
these loans to their clients, the first few planners responded negatively, but
were largely unable to explain why they gave the response they did. This
raised an interesting question: If a financial planner’s job is to advise
people on how to plan their finances for the future, how can they give someone
good advice if they’re not fully versed on of all the options out there? Their
lack of knowledge could pose a disservice to seniors who may need the product,
but are not given the choice. One
financial planner mentioned a limited understanding of the product, focusing
primarily on what he “knows” about the “industry’s abuse against seniors.” This
advisor, along with another, said cost analyses they’ve run on reverse
mortgages never break even, and their situation models are always in favor of
either selling the home and using the proceeds toward rent, or taking out a
home equity loan/line of credit. While
the planners I spoke with up to this point seemed entrenched in their negative
preconceptions, one conversation pointed to the possibility of turning the
tide. This
particular financial advisor had some knowledge of reverse mortgages after
looking into the product for her elderly aunt, and was willing to learn more.
Through both email and phone correspondence, the questions she asked sparked a
dialogue about the loans.
I
ended up sending an email to the advisor, asking for her thoughts on the HECM
Saver program, which has much lower upfront costs due to a lower insurance
premium. She called me about an hour later, after looking into the Saver, and
said she had previously been completely unaware of the product. After
doing some research, though, this financial planner acknowledged the “plus
side” to the HECM Saver, i.e. the lower insurance premium. She said she would
“definitely” look at the program if she were considering a reverse mortgage. While
she couldn’t be considered reverse mortgage’s biggest advocate by any stretch
of the imagination, progress was made in educating at least one financial
advisor…. all with one email about the HECM Saver. Whether
the HECM Saver is the key to reaching this group of individuals isn’t clear,
but there is certainly a lack of understanding about the role reverse mortgages
could play in the future of retirement planning. It’s
easy to point the finger and blame those who choose not to learn about the
program, but maybe the industry needs to turn that finger around and ask, when
was the last time I reached out to a financial planner and let them know about
the Saver—or reverse mortgages in general? October 1, 2013 Please not the FHA has eliminated the HECM SAVER Program as of today. The only two programs available now are the Adjustable and the Fixed rate programs. And the closing costs have come down considerably. Need more information, contact George Lagarde at GLagarde@AllWestern.com and the web site at: ReverseMortgageLV.com
Using your nest to help with your nest egg is becoming a more
common way to round out a financial plan during retirement.
Even after the bursting of the housing bubble, the biggest
financial asset many retirees have is their home. But because that money is
tied up in the equity of the house, it's an investment that has been difficult
to count on as a source of income.
Reverse mortgages have long been an option. However, until
recently, they were the Wild West of retirement planning. High upfront costs,
poor disclosure and dodgy sales pitches made them an option that many advisers
avoided.
Now, with the introduction of reverse mortgages backed by the
Federal Housing Administration in late 2010, more financial planners are adding
them to their tool kit.
Primarily, they're using them as a way to provide a steady stream
of tax-free income that can last the rest of a retiree's life. They can also be
used as a way to provide a cushion against a big, but temporary, drop in the
markets.
"Between Social Security and a reverse mortgage, for some
people there might be enough money to cover their needs-based expenses,"
says Mark Cortazzo, senior partner at Macro Consulting Group, a financial
advisory firm in Parsippany, N.J. "Then you can use a portfolio, or maybe
a part-time job, to cover the 'wants.' "
While any financial-planning decision should be thought through, a
reverse mortgage literally involves the roof over your head. Take the time to
understand the implications of a reverse mortgage, the costs and the different
options. "It's a tool…but it's something that people need to be careful
with," says Mr. Cortazzo.
Borrowers need to be sure they will have enough money in future
years to pay real-estate taxes and homeowners insurance, or otherwise face
possible eviction. Married couples should be sure both names are on the
mortgage to avoid a situation where after the death of the sole spouse named on
the loan, the surviving spouse has to pay off the loan. And retirees should be
wary of brokers pushing higher-fee reverse mortgages.
A reverse mortgage is essentially a loan that allows the owner of
a house or condo to convert some of the equity in the property into cash. Such
mortgages differ from a traditional loan in that the money doesn't need to be
repaid until the home is sold or no longer used as a principal residence.
Another major difference
is that there are no credit and income requirements. These mortgages can be set
up to pay out all at once in a lump sum, on a monthly basis or as a line of
credit. (Details can be found at the website of the Department of Housing and
Urban Development. Go tohud.govand search for
"reverse mortgage.")
One of the quirks of reverse mortgages that makes them appealing
for a financial plan is that when set up on a monthly basis, over a period of
many years a homeowner could receive more money in payouts than the house is
worth at the time of the loan.
Roberto Nascimento, director of reverse mortgages at Arlington
Financial in Yonkers, N.Y., takes the example of a 66-year-old with a house
valued at $340,000. After subtracting the closing costs on a low-cost,
FHA-backed floating-rate reverse mortgage known as a "Saver," that
retiree could get a loan for about $173,000, which translates into a monthly
check of $1,006 for the rest of his or her life.
By age 86, the payouts would have totaled more than $240,000;
after another decade, the total would be $360,000. A "standard"
reverse mortgage, with higher closing costs, would pay out $414,000 over 30
years.
Financial planner Harold
Evensky, in Coral Gables, Fla., is taking a different tack with reverse
mortgages. He has long recommended retirees keep on hand enough cash to meet
two years of expenses, thereby avoiding having to sell investments at depressed
prices during a bear market to pay the bills.
Mr. Evensky says that
with a reverse-mortgage line of credit known as an HECM Saver, that cash bucket
can be reduced to just six months. When things get ugly in the market, the
retiree taps the equity line. When markets improve, he or she can sell
investments and repay the loan.
The credit line is permanent, and the retiree won't have to start
paying back the loan right away. In addition, the amount available to borrow
will increase over time.
Mr. Cortazzo, meanwhile, points to an example where a reverse
mortgage is being used to help keep the mother of one of his clients in her
house and pay for the in-home care she needs. Not only does the reverse
mortgage keep her in her house, her sons won't have to incur tax penalties by
dipping into their retirement accounts to help pay for her care.
They just give up the possible future benefit of proceeds from
selling the house. "That's the sweet spot," says Mr. Cortazzo.
Earlier this year,
Frank Fertelmes gave his car to his 21-year-old grandson to get back-and-forth
to college.
Mr. Fertelmes's
daughter could no longer drive her son to school each day with her family's one
car, as she had just started a new job after being unemployed for over a year.
Mr. Fertelmes' son-in-law couldn't help out either, as he is still on medical
leave after a serious car accident.
The 81-year-old
Stratford, Conn., native also pays for the occasional car repair and
maintenance. And he likes to slip his grandson, who goes to school full time
and takes any part-time work he can get mowing lawns and doing other handiwork,
the occasional $20 for lunch or gas money.
"The downturn
put a strain on his parents, and he needs my help," Mr. Fertelmes says.
Grandparents, like
Mr. Fertelmes, are increasingly playing a bigger financial role in the lives of
their grandchildren.
The economic strain
on their children and grandchildren, due in part to higher unemployment, is
prompting more grandparents to pitch in and pay for everything from toys to
insurance to college tuition.
Yet some grandparents
are making financial mistakes that could put their own financial future in
jeopardy. Promising too much to grandchildren, not saving enough for their own
possible health-care needs and paying off their grandchildren's loans are some
of the mistakes well-meaning grandparents are making, say financial advisers.
"Grandparents
can sometimes give too much support," says Oliver Pursche, a Suffern,
N.Y., financial adviser.
Grandparents today
are younger and have more financial resources than ever before. The majority of
grandparents are working age baby boomers between the ages of 45 and 64,
according to a recent study by the MetLife Mature Market Institute. In the past
decade, the inflation-adjusted income for households age 55 and older has risen
to 34% of the nation's total, up from 28%. Yet during that same period, income
of households ages 25 to 44 fell to 36% of the total from 43%, according to
MetLife. In turn, some grandparents feel compelled to help their progeny whose
income has fallen behind.
However, Mr. Pursche
has seen several grandparents make the basic mistake of lending support before
they "do the math" and figure out what they can actually afford to
give.
Lazetta Rainey
Braxton says grandparents can make the mistake of not planning to cover the
expenses of catastrophic events, such as significant medical and long-term care
costs. The Chicago-based certified financial planner says while it may be
difficult for some grandparents, especially those who are young and healthy
now, to throttle back support for their grandchildren, they may need to do so
to ensure they have enough money saved for possible health-care expenses later
in life.
"One of the
biggest gifts a grandparent can give is being able to afford his or her own
care," she says.
Among the biggest
mistakes William Martin sees grandparents make is helping pay off their
grandchildren's debt. The State College, Pa., certified financial planner says
this can be dangerous because it not only shrinks the grandparents' balance
sheet but it can also enable the grandchildren to make poor debt decisions down
the road and ultimately prevent them from becoming "financially
healthy" adults.
While helping a
grandchild with a school loan, within reason, may be appropriate, he says,
grandparents should think twice before helping pay off junior's credit-card
bill, for example. "The key is to [reward] good choices, not bad
ones," says Mr. Martin.
Grandparents who want to help the next generation, but who may not
be able to permanently part with their cash, may consider an informal loan
agreement with their grandchild, says Ted Halpern, a Rockville, Md., financial
adviser. Grandparents can either put a basic loan agreement in writing or do it
simply with a handshake.
One of his clients
who lent her grandchild money for a home down payment created a written
agreement that included the loan amount, interest rate and monthly payment. The
interest rate on the loan was less then what the grandchild would have paid at
a bank, and the loan came with an "unwritten" understanding that the
repayment term could be extended if needed.
For grandparents who
can't give money, Michael Lynch, a Shelton, Conn.-based certified financial
planner, recommends they give support in other ways such as volunteering with
their grandchild or encouraging them to pursue an education.
"Sharing your
values is an important gift," says Mr. Lynch.
The following article published by Forbes Magazine
discusses the benefits of using a Reverse Mortgage as a Financial Tool to help
Divorcing couples make their final decisions on their future into retirement.
Please read it, and if you have any questions or concerns
about this program, feel free to contact on me; George Lagarde at GLagarde@
AllWestern.com. ReverseMortgageLV.com
Divorcing later in life is not a
new phenomenon, but it is becoming more and more common. Indeed, the increased
occurrence of “grey divorce,” as it’s called, has been identified as a
significant 21st century divorce trend: Even though the overall divorce
rate is actually declining, it’s on the rise among older generations.
Those of us in the business of helping people plan for secure financial futures
have long known that grey divorce presents a unique set of challenges to our
clients. Sure, there is overlap, but women divorcing after long marriages (or
brief marriages that began later in their lives) typically face different
financial concerns –and may have access to different financial products –than
their younger counterparts. For example, a recent article in The Wall Street Journal (written by Kelly Greene) explains how a
loan called a “reverse mortgage” can be a useful financial tool for retirees.
This type of loan is becoming increasingly popular because instead of making
payments to a lender, the homeowner actually receives monthly
payments, increasing the amount she owes. Or, she might opt to receive a lump
sum, or maintain a ready line of credit. The loan (and interest) come due
when the homeowner dies, moves out, sells the home, or if property taxes or
insurance premiums go unpaid. Typically, the home is sold to repay the loan. As explained in the article, a
reverse mortgage provides a mechanism for homeowners at least 62 years old to
borrow against the equity in their home. While there’s no restriction on the purpose
of the loan, the funds are commonly used to pay for home repairs or
modifications, home health care or medical expenses. However, now that the
financial services industry has developed new government-insured products,
borrowing costs for reverse mortgages have come down, and these types of loans
are becoming basic financial management tools, rather than just last-resort
methods to increase cash flow. So, what does all this mean for
the divorcing woman? Well, for those who are close to
62 years old, the possibility of taking a reverse mortgage loan could represent
a new factor to consider when deciding whether or not to keep the house. There are many angles to that decision,
including:
equity and potential resale value on one side,
maintenance and repair costs,
property taxes,
insurance premiums,
and more!
Even so, the potential utility of
a reverse mortgage in your financial plan might tip the balance toward keeping
the house. Discuss it with your divorce financial planner. For women whose divorces are
behind them, a reverse mortgage might represent a new strategy for making their
settlements last as long as possible. For example, using a reverse mortgage to
provide cash income during retirement could save you from having to sell
temporarily depressed investments. In the event of a drop in the market,
payments from a reverse mortgage can be used to cover expenses until the value
of your investments sufficiently rebounds. The Wall Street
Journalreports that taking a reverse mortgage can also have
implications for your tax bill, and for configuring your potential Social Security income. You
may be able to limit your income tax exposure by using cash flow from a reverse
mortgage, rather than taxable withdrawals from a 401(k) or other retirement
investment, to pay off a traditional mortgage or other debts. If you can delay
taking Social Security by using a reverse mortgage as a source of income, you
can increase the monthly payment you will eventually receive. Used judiciously, a reverse
mortgage can be a very useful part of the divorcing or divorced woman’s
financial strategy, and as a Divorce Financial Strategist™ , I recommend you see how this financial
tool might best serve you. The Consumer Financial Protection Bureau is an excellent place to get more
information before you look for a lender. If you decide to pursue such a loan,
be especially wary of “advisors” who try to steer your reverse mortgage
payments into expensive or risky investments. As always, it’s best to be
well-informed, and well-advise. George Lagarde
While we continue to hear about reverse mortgages as a last resort, more are turning to
it as a tool for the affluent marketplace as a vehicle for advanced
planning. Paul Savery, a reverse mortgage
consultant with Wells Fargo told the Norwich Bulletin that some people are
using a reverse mortgage to buy or improve a second home.
With housing prices at record lows, some wealthy homeowners
are going bargain hunting with their reverse mortgage
credit line as a way to close quickly on homes that are being sold at
distressed prices.
The article also describes other strategies of how you can
use a reverse mortgage as an estate-planning tool which is something that will
eventually be more common, but so much attention being brought on people using
reverse mortgages to purchase shady investment products, I was surprised to see
the article.
What’s not clear is how long it will take until using a
reverse mortgage as a financial tool rather than a loan of last resort becomes
a reality. Thoughts?
By the age of 85 there are roughly
six women to every four men. At age 100 the ratio is more than two to one. And
by age 122—the current world record for human longevity—the score stands at
one-nil in favor of women; this longevity phenomenon
is known as “the sex ratio.” I
recently informed one of my soon-to-be-divorced-middle-aged-male friends that
if he kept his “shelf-life” up his dance card will always be filled!
Women still outlive men by about 5
to 6 years and the theories range from biological,
behavioral, and sociological, and have been bandied about in pool halls and
academic halls alike–most likely it’s a hybrid of each (and some
unknown Xfactor). But the fact remains, the future will be a
feminized gerontocracy!
Fountain of Age
One of the most influential books on
aging I ever read was by the late Betty Friedan: Fountain of Age. From that thought provoking
work, Friedan posits two theories why women may actually age longer and
better than men:
1. The X-Over: As women age they move into new stages of HUMAN
DEVELOPMENT (not decline). Women reclaim their “male side” of
assertiveness, more commanding and adventurous nature. Men reclaim their
passive, nurturing, and contemplative “feminine side.” We quite
literally X-Over and pass each other like ships in the sea of mid-life. Friedan
argued that the female advantage comes as older women now enjoy integrating
masculine values; which our culture legitimizes. The male disadvantage of
integrating feminine values in older age is that it’s viewed as a crisis,
illness, or disengagement that precedes death.
2. Aging and Discontinuity Theory: “Do changes that take place in women’s roles over a lifetime
account for their greater flexibility and resilience in age?”
As the theory goes, women experience
many more role changes in the life course than do their male counterparts, for
example; student, mother, empty nester, second career, widowhood (70% more
likely to lose spouse). Women spend on average 11.5 years out of the workforce
as compare to men at 1.3 years.
The argument is that women become
more accustomed to change and the impermanence of life. That ability is a
longevity advantage for successful aging. Men have fewer role changes and in
fact, retirement for men has been called “the role-less role.” They are less
equipped to handle the changes brought on by the aging process (men’s suicide
rates are higher in old age).
Women Aging in Place Alone
Regardless of whether you embrace
Friedan’s theories, the fact is aging is mainly a women’s issue because of
longevity advantages—whatever the cause/s. This should get women thinking about
the future, and thinking outside the box about aging in place options…
An estimated 50% of us have
a will or trust! This is not good news!
Most people have not yet
comprehended (or accepted) that dying without a will is a very costly mistake
that will negatively impact all you leave behind. It’s not just about the
hassles and frustrations your heirs will go through potentially for years, but
the expenses involved. Ultimately, the state you live in will make
decisions regarding your estate that will not distribute it the way you would
have chosen. In a nutshell, get it done now and leave a legacy of
respect, instead of resentment.
For those who do have a
will, it is important to consider any changes in mental and physical health, as
these could greatly impact the outcome of someone’s wishes. For example,
let’s say mom’s healthcare power of attorney states that dad makes all
decisions for mom in the event she is incapacitated, vegetative state,
etc.
Suddenly dad is exhibiting odd behavior and is diagnosed with
Alzheimer’s, which is progressing rapidly. Can he now make sound
decisions for mom? Or, mom may not think about these details and this is
the time for the children to talk with her about it.
So many Boomer children
don’t know how to talk with their parents about these delicate
issues, so permit me to offer some very sound advice. It has to be done;
it has to be discussed, as painful as it is. If left “under the carpet,”
no answers will be available to you should they become infirm or die. Get
the answers now, and do so with love and compassion.
Here’s one example: “Mom,
we were thinking about yours and dad’s situation. Now that dad is showing
a decline in health, new decisions have to be made and documented so your
wishes are fulfilled the way you would like them to be. Dad is no longer
capable of understanding complex issues, and you will need to choose a new
healthcare power of attorney, so we can ensure the correct decisions will be
made. Can you please give this some thought? Can we make an
appointment with your attorney to have this changed soon?
This one example really gets
you thinking. Anytime there is a significant change in your life or a
parent’s life, consider discussing with an elder law or estate planning
attorney. Being proactive isn’t always easy or pleasant, but it can head
off gut-wrenching issues that will occur at some point, especially if you have
elderly loved ones. Making sound decisions in the midst of crisis is not
the optimal time to think clearly.
Lead with love, and start
communicating while you can!
Julie Hall, The Estate
Lady®, is the foremost national expert on personal property in estates,
including liquidating, advising, and appraising.http://www.TheEstateLady.com She is also the Director of American Society of Estate
Liquidators®, the national educational and resource organization for estate
liquidation. http://www.aselonline.com
·Reversing the Conventional Wisdom: Using Home Equity to
Supplement Retirement Income
Reversing the Conventional Wisdom: Using Home Equity
to Supplement Retirement Income
by Barry H. Sacks, J.D., Ph.D., and Stephen R.
Sacks, Ph.D.
Barry H. Sacks, J.D., Ph.D., is a practicing
tax attorney in San Francisco, California. He has specialized in
pension-related legal matters since 1973 and has published numerous articles in
legal journals.
Stephen R. Sacks, Ph.D., is professor emeritus of economics at
the University of Connecticut. He maintains an economics consulting practice in
New York and has published articles on operations research.
Executive Summary
·This paper examines three strategies for using home equity, in
the form of a reverse mortgage credit line, to increase the safe maximum
initial rate of retirement income withdrawals.
·These strategies are: (1) the conventional, passive strategy of
using the reverse mortgage as a last resort after exhausting the securities
portfolio; and two active strategies: (2) a coordinated strategy under which
the credit line is drawn upon according to an algorithm designed to maximize
portfolio recovery after negative investment returns, and (3) drawing upon the
reverse mortgage credit line first, until exhausted.
·A three-spreadsheet stochastic model is described, with one
spreadsheet incorporating each strategy. The three spreadsheets are run
simultaneously, with the same investment performance and withdrawal amounts in
each. The cash flow survival probability over 30 years is determined for each
strategy, and the comparisons are presented graphically for a range of initial
withdrawal rates. We find substantial increases in the cash flow survival
probability when the active strategies are used as compared with the results
when the conventional strategy is used. For example, the 30-year cash flow
survival probability for an initial withdrawal rate of 6 percent is only 55
percent when the conventional strategy is used, but is close to 90 percent when
the coordinated strategy is used.
·The model also shows that the retiree’s residual net worth
(portfolio plus home equity) after 30 years is about twice as likely to be
greater when an active strategy is used than when the conventional strategy is
used.
The overriding objective for many retirees is to maintain cash
flow throughout their retirement years, to avoid “running out of money” in
their later years. Cash flow survival is the central theme of this article.
Although
more than half of retirees age 65 and older (64 percent) get at least half of
their retirement income from Social Security,1there is a significant portion of the population of retirees
whose primary source of retirement income is a portfolio of securities, often
in a pre-tax account such as a 401(k) plan or a rollover individual retirement
account (IRA). We will refer to any such account, whether pre-tax or after-tax,
as an “account.”2
It has
long been accepted that the maximum safe (or “safemax”) annual withdrawal from
an account begins with a first year’s withdrawal equal to between 4.0 percent
and 4.25 percent of the initial portfolio value. Subsequent years’ withdrawals
then continue at the same dollar amount each year, adjusted only for inflation
(thus maintaining constant purchasing power). In this context, the term “safe”
means a 90 percent or greater probability that the account will have sufficient
assets to make such annual payments for at least 30 years.3
Many retirees find that the safemax amount of annual withdrawal
is uncomfortably limiting and therefore tend to draw more than that amount.
This article considers three strategies for coping with the economic risk, the
risk of exhausting cash flow, that derives from taking withdrawals in excess of
the safemax amount.
The
three strategies considered all involve the use of home equity as a supplement
to withdrawals from the account. The conventional wisdom holds that home
equity, drawn upon in the form of a reverse mortgage (discussed below) or
similar product,4should
be used as a last resort, only if and when the account is exhausted.5This is a rather passive approach. We show that the probability
of cash flow survival is substantially enhanced by reversing the conventional
wisdom. In particular, we show that cash flow drawn from home equity using
either of two more “active strategies,” in conjunction with withdrawals from
the account, yields cash flow survival probabilitysubstantially greaterthan
the more passive approach of using home equity as the last resort (the
“conventional strategy”).
One of
the active strategies is quite simple: a straightforward reversal of the conventional
wisdom. In this strategy, a reverse mortgage credit line is established at theoutsetof retirement, and the
credit line is drawn uponevery yearto
provide the retirement income until it is exhausted. Only after the reverse
mortgage credit line is exhausted are withdrawals taken from the account. This
is the “reverse-mortgage-first strategy.”
The other active strategy is more sophisticated. It also uses a
reverse mortgage credit line, but withdrawals from the credit line are taken in
some years and not others. The withdrawals are taken according to an algorithm
described later in this paper. Because the algorithm consists of coordination
between the account and the line of credit, this strategy is termed the
“coordinated strategy.”
Some Fundamental Considerations
Before
we examine the effect of these strategies, it is important to emphasize that a
reverse mortgage is not necessarily a useful vehicle for every retiree who has
substantial home equity. A retiree whose primary source of retirement income is
a securities portfolio and who also has substantial home equity must decideearlyin retirement whether to
live within the safemax limit set by his or her portfolio. This decision is a
fundamental component of overall retirement planning.
The
decision process includes, among other things, thebalancebetween the desired
consumption level, on the one hand, and the bequest motive and/or the economic
safety net of the home equity, on the other hand. The decision process also
must take into account the degree of economic discipline required to live
within the safemax limit.
If the
retireedoesconclude
that he or she would, on balance, prefer to live beyond the safemax level and
wants to remain in his or her home as long as possible, a reverse mortgage,
including its substantial costs, is one tool to consider. Although the costs do
not affect the retiree’s cash flow, they become part of the debt, along with
the cash drawn and interest accrued, to significantly reduce the equity
remaining when the retiree ultimately leaves the home.
The
thrust of this article is not whether a retireeshouldtake a
reverse mortgage. Rather, if the retiree has determined to live beyond the
safemax level of the portfolioandconsequently
needs to rely on home equity for cash flow to supplement the cash from the
portfolio, this paper shows how the active strategies provide substantially
greater long-term cash flow survival probability than the passive conventional
strategy.
The Rationales for the Two Active Strategies
In the
cases in which withdrawals from a securities portfolio lead to exhaustion of
the portfolio, it is most often because the investment performance in theearly yearsof withdrawal has been
weak or negative. Thus, the losses or even the weak gains in the early “down”
years, coupled with the withdrawals in those years, lead to the portfolio’s not
having enough assets to recover in the later “up” years. The two active
strategies are designed to offset that situation by either: (1) allowing the
portfolio to grow bytaking no
withdrawalsfrom it during any of the early years of retirement until the
reverse mortgage credit line is exhausted (the reverse-mortgage-first
strategy); or (2) allowing the portfolio to grow during the early years of
retirement by taking no withdrawals from it only in those early years that
follow years in which the portfolio’s performance was negative (the coordinated
strategy).
Rationale for the Reverse-Mortgage-First Strategy.The reverse-mortgage-first strategy allows the account to grow
during the early years of retirement. Generally, over the years that the
reverse mortgage credit line is drawn upon and exhausted, the portfolio will
grow at an average rate greater than inflation. Therefore, in the year
following the one in which the reverse mortgage credit line is exhausted, the
withdrawal will be a smaller percentage of the portfolio than the initial
withdrawal would have been at the outset of retirement. Furthermore, by that
time, the retiree’s life expectancy is less than it was at the outset of
retirement. These two factors together favor the lifetime cash flow survival of
the portfolio.
Rationale for the Coordinated Strategy.The coordinated strategy is based on the following algorithm: at
the end of each year, the investment performance of the account during that
year is determined; if the performance was positive, the next year’s income
withdrawal is from the account, and if the performance was negative, the next
year’s income withdrawal is from the reverse mortgage credit line.6In this way, the account is spared any drain (resulting from
withdrawal) when it is “down” because of its investment performance. This
leaves the account more assets to “recover” in subsequent “up” years. This is
done when most necessary—in the early years of retirement, so the account grows
before the reverse mortgage credit line is exhausted.7
It is not obvious whether the cash flow would survive just as
long, or longer, under the reverse-mortgage-last strategy as under either of
the active strategies. The only way to compare the results of the three
strategies is with a quantitative test.
The Analytic Technique
To compare the two active strategies with the
reverse-mortgage-last strategy, we have constructed a spreadsheet model. The
model has the following input parameters:
1.The
initial value of the retiree’s account
2.The
value of the retiree’s home (we assume that the home is not encumbered by any
mortgage debt)
3.The
initial withdrawal rate as a percentage of the account value
The
model uses three worksheets run simultaneously. The three worksheets are
identical in all respects (including the investment performance of the account,
the rate of inflation, and the amount drawn by the retiree)exceptfor thestrategyused to determine whether
retirement income is withdrawn from the account and/or the reverse mortgage
credit line.
On each
worksheet, the calculations of investment gain or loss, and of retirement
income withdrawal, are performed for each year in a 30-year period. The
investment gain or loss is determined stochastically, as is the inflation
adjustment to the withdrawal amount.8In the
course of the calculations, the cash flow either survives or it does not
survive. It survives if there is enough money from the account and/or the
reverse mortgage credit line to make the required income withdrawals for all 30
years.
The
30-year calculation is repeated 1,000 times. In a certain number of those
repetitions, the cash flow will survive for 30 years, and in the other
repetitions it will not. (As noted above, the two most significant determinants
of cash flow survival are the initial withdrawal rate and whether the higher
investment earning years occur early or late in the 30-year sequence.) In each
of the 1,000 repetitions, the initial withdrawal rate is the same, and the
average investment return is the same, but the sequence of investment returns,
being randomly selected, is not the same in each repetition of the calculation.
A simple count is made of cash flow survival over the 1,000 trials (with the
three worksheets run simultaneously in each trial and results of the 1,000
trials shown on a histogram for each worksheet). The percentage of the
repetitions in which the cash flow survives is termed the “cash flow survival
probability.”9
Our
primary focus is on thecomparisonof the
cash flow survival probabilities of the three strategies. A secondary focus is
on the comparison among the three strategies of the retiree’s residual net
worth at the end of 30 years.
The Portfolio
The securities portfolio held by the account, in all the
analyses and results shown, is a 60/40 portfolio comprised of the following
indices, in the following proportions:
·Fixed Income (40 percent): Bar Cap Int.-Term Gov’t./Credit Bond
Index, 15 percent; U.S. 1 Year Const. Maturity, 15 percent; Bar Cap Long-Term
Gov’t./Credit Bond Index, 10 percent
In our Monte Carlo simulations, we used investment return data
on these indices from the 37-year period from 1973 through 2009. This captured
several periods of significant volatility in the securities markets, including
the most recent decline in 2008. Although this inclusion may be excessively
pessimistic, we feel that failure to include it would be unrealistically
optimistic.
We assumed a normal distribution of the investment returns from
each asset class. The geometric means and standard deviations derived from the
annual performance of each asset class over the 37-year period are set out in
Appendix A. Also, a correlation matrix from the asset classes’ annual
investment performances over that period was constructed and incorporated into
the simulation program.
Because the portfolio composition was the same in each of the 30
years of each trial, the portfolio was, in effect, rebalanced each year.
We
repeated all the calculations and analyses, but with a 70/30 asset allocation
in the portfolio, and with an 80/20 asset allocation. The results were
essentially the same. This finding is consistent with Bengen’s observation that
“for a wide range of stock allocations—between 40 percent and 70 percent—the
safemax is virtually constant.”10
We also repeated all the calculations and analyses, but using
the investment return data for the same indices from the 32-year period of 1973
through 2004 instead of the 37-year period from 1973 through 2009. The
geometric mean value of the return of each index for the 32-year period is
higher than for the 37-year period; that is not surprising, because the 32-year
period did not include the significant decline of 2008 and its aftermath. (The
mean values and the standard deviation values of the returns for the 32-year
period are set out in Appendix B.) Some results of using these higher
investment returns are shown later in the paper.
The Reverse Mortgage
Reverse
mortgages come in several forms, each with its own set of features and
parameters.11The
basic feature for the strategies we explore is the reverse mortgage credit
line. The credit line is available as a feature of the home equity conversion
mortgage (HECM), with the largest credit line coming from the “standard” HECM.
Therefore, we use the reverse mortgage parameters of the standard HECM. The
parameters most directly relevant to cash flow considerations are the home
value limit and the “expected rate.”
The
home value limit is the maximum home value that can be considered in
determining the amount of loan (or line of credit) available. Since 2009 it has
been set at $625,500. Although it had been anticipated to revert to its 2008
value of $417,000 on January 1, 2012, the current figure has now been extended
at least through December 31, 2012.12
HUD
uses the expected rate to determine factors (called “principal limit factors”)
that multiply the home value (or home value limit) to calculate the amount of
the loan (or line of credit) available as a function of the borrower’s age.13We use the expected rate only once in each 30-year simulation
trial, at the time the loan (or line of credit) is established. It is equal to
the 10-year constant maturity U.S. Treasury rate.14The lower the expected rate and the older the borrower, the
greater the amount of credit available.
We ran our simulations using the “mean expected rate” and the
“current expected rate.” The mean expected rate is the geometric mean of the
10-year constant maturity Treasury rates for the period from which the
investment return data is taken. (The mean rate for the 37-year period is 6.9
percent and the mean rate for the 32-year period is 7.5 percent.) Using mean
rates has the advantage of internal consistency. The current expected rate, in
effect in December 2011, is 5 percent (because it is defined as the greater of
5 percent or the actual rate). Although this figure is not from the same period
as the investment return data, its use has the advantage of more realistically
reflecting the amounts available currently and likely to be available during
the next several years.
Table 1 sets out the range of approximate amounts available
under each expected rate used in this paper, for ages 65 through 90. These
figures are for home values equal to the pre-2009 HECM limit of $417,000 or
greater. For home values greater or less than this limit, the available credit
line amounts are essentially proportional. Thus, a home worth $300,000 would
give rise to a credit line amount equal to about 300/417 = 72 percent of the
amount set out in Table 1. Likewise, a home worth $600,000 would give rise to a
credit line equal to about 600/417 = 144 percent of the amount set out in Table
1. When interest rates are higher, and hence amounts of credit available are
lower, the effect on our calculations would be the same as lowering the home
value, as described later in the paper.
Results
The essential result shown by our analysis is the substantial
increase in cash flow survival probabilities that comes from reversing the
conventional wisdom. This result holds true across a wide range of portfolio
asset allocations, of home value to account value ratios, and of expected
rates, and both with and without the use of safeguards similar to those
described by Guyton (2004).
To best illustrate these results, we choose a specific example,
described below. The results are a set of figures showing the cash flow
survival probability for a range of 15 years to 30 years, under the set of
assumptions described. There is a figure for each of three initial withdrawal
rates, 5.0 percent, 6.0 percent, and 6.5 percent. The results in this example
are indicative of both the qualitative and quantitative results of using a wide
range of assumptions.
Before examining the results of the three strategies of using
the reverse mortgage credit line, we first consider the results when the
reverse mortgage credit line is not used at all. When the account is the only
source of the retiree’s income, cash flow is not likely to survive very long if
the initial withdrawal rate is much above the safemax level of 4 percent of the
initial account value. Figure 1 shows the probabilities of cash flow survival
for a range of initial withdrawal rates from 4 percent to 7 percent of the
initial account value.
It is clear from Figure 1 that the probability of cash flow
survival for 30 years falls below 90 percent when the initial withdrawal rate
is 4.5 percent or more. Similarly, the probability of cash flow survival for 25
years falls below 90 percent when the initial withdrawal rate is 5 percent or
more. At initial withdrawal rates of 5.5 percent or more, the cash flow
survival probabilities fall to levels that should generate serious concern for
the retirees whose life expectancies are greater than 25 years.
Results When the Reverse Mortgage Credit Line Is Added.We now illustrate the cash flow survival probabilities when the
reverse mortgage credit line is used in addition to the account, in all three strategies.
The illustrative example uses the following input data:
1.The
initial account value is $800,000.15
2.The
home value is equal to the pre-2009 HECM limit of $417,000. (We are not aware
of any reverse mortgages currently available that provide loans based on home
values higher than the HECM limit and provide the loans in the form of a credit
line.)
3.The
initial withdrawal rate is the primary variable used in our comparison of the
three withdrawal strategies. We show results for initial withdrawal rates of
5.0 percent, 6.0 percent, and 6.5 percent.
In this example, we assume the retiree is age 65, and the
resulting credit line available is approximately $266,000 in the initial year
at the current expected rate and approximately $183,000 at the 37-year mean
expected rate. In both the reverse-mortgage-last strategy and the coordinated
strategy, the reverse mortgage credit line is established later in the 30-year
sequence, so the amount available is greater.
In considering this example, it is important to note that the
home value used to determine the reverse mortgage amount is approximately equal
to 52 percent of the account value. If the home value were lower, or the
account value were higher, the ratio of home value to account value would be
lower; as a result, the effect of the reverse mortgage credit line on the
probability of cash flow survival would also be lower. We show below a
quantitative measure of the impact on our results of the ratio of home value to
account value, both above and below this 52 percent ratio.
Results from Withdrawals Near the SafeMax Rate.Because the probability of cash flow survival for 30 years with
initial withdrawal rates in the range of 4 percent to 4.5 percent is near 90
percent even without the use of the reverse mortgage, the use of the reverse
mortgage credit line makes little difference. That is true irrespective of
which of the three withdrawal strategies is used.
Results with a 5 Percent Initial Withdrawal Rate.The first initial withdrawal rate we examine, as we compare the
three withdrawal strategies, is 5.0 percent. This initial withdrawal rate
yields a significant increase in the annual withdrawal amounts over the safemax
rate. In dollar terms, with an $800,000 initial account value, it reflects an
$8,000 increase in initial annual withdrawal over the safemax amount. In
percentage terms, it is an increase of 25 percent over the 4.0 percent safemax
rate.
Figure 2 shows the probability of cash flow survival for the
three withdrawal strategies, with a 5.0 percent initial withdrawal rate, for
periods from 15 years to 30 years. It is clear from Figure 2 that, with a 5
percent initial withdrawal rate, the coordinated strategy and the
reverse-mortgage-first strategy both result in cash flow survival probabilities
significantly greater than the result of using the reverse-mortgage-last
strategy. This is true with both the current expected rate and the mean
expected rate. Specifically, the 30-year cash flow survival probability for
both of the active strategies is approximately 95 percent with the current
expected rate and approximately 90 percent with the mean expected rate. The
cash flow survival probability for the reverse-mortgage-last strategy is less
than 80 percent with both expected rates. Thus, the active and passive strategies
result in a difference in the cash flow survival probabilities of 10 to 15
percentage points.
Results with a 6 Percent Initial Withdrawal Rate.We next take a larger jump in initial withdrawal rate in our
comparison of the three withdrawal strategies by examining the results of a 6.0
percent rate.
This is almost 50 percent more than the safemax rate. In dollar terms, with an
$800,000 initial account value, it reflects an increase of almost $16,000 in
initial annual withdrawal over the safemax amount. This rate is such that,
absent the reverse mortgage component, it results in a 60 percent probability
of cash flow survival for 25 years and less than a 50 percent probability of
cash flow survival for 30 years.
The results are shown in Figure 3. With the two active
strategies, the 25-year cash flow survival probability is close to 90 percent
with the current expected rate and 85 percent with the mean expected rate. The
30-year cash flow survival probability is over 80 percent with the current expected
rate and over 70 percent with the mean expected rate. By contrast, the
conventional (reverse-mortgage-last) strategy results in a 25-year cash flow
survival probability of about 70 percent and a 30-year cash flow survival
probability under 55 percent with both expected rates.
Results with a 6.5 Percent Initial Withdrawal Rate.The next initial withdrawal rate we examine is 6.5 percent. The
results are shown in Figure 4. It is clear from Figure 4 that, with a 6.5
percent initial withdrawal rate, the 25-year cash flow survival probability,
with either of the active strategies and the current expected rate, is below 90
percent. And the 30-year cash flow survival probability with either of the
active strategies is barely above 70 percent. The reverse-mortgage-last
strategy results in a 30-year cash flow survival probability of only 40
percent.
However, before hope is lost for initial withdrawal rates as
high as 6.0 percent or 6.5 percent to have 90 percent or greater cash flow
survival probability, we point out that there are at least three situations in
which these initial withdrawal rates, and initial withdrawal rates even higher,
can still result in cash flow survival probabilities of 90 percent or greater:
1.The
first situation is where the ratio of home value to account value is higher
than the ratio in our example. Holding the home value in our example constant,
this situation would occur only where the account value is lower than in our
example; in that case, the dollar amounts of the withdrawals would also be
lower. This situation is illustrated in the next section.
2.The
second situation is the obvious one, where there are higher investment returns
on the portfolio than those used in our example. This situation is illustrated
later in the paper.
3.The third
situation is the one in which certain safeguards are used. The safeguards are
described and illustrated later as well.
The Impact of the Ratio of Home Value to Account Value
Obviously,
the greater the home value, the greater the increase it can provide to the cash
flow survival probability. In the example we considered above, the ratio of
initial home value to initial account value was approximately 52 percent.16We now show how varying this ratio, as we hold the other
parameters constant, alters the effect the different strategies have on cash
flow survival probability. Specifically, we show in Figure 5, using an initial
withdrawal rate of 6.5 percent, the 30-year cash flow survival probability as a
function of the ratio of initial home value to initial account value.
This
figure shows a very high probability of cash flow survival when the ratio of
home value to account value equals or exceeds 100 percentandone of the active
strategies is used. For example, when the ratio is 100 percent, the conventional
(reverse-mortgage-last) strategy still results in less than a 50 percent cash
flow survival probability for 30 years, and the active strategies (at the
current expected rate) result in a greater than 90 percent cash flow survival
probability.
The active strategies show a sharp increase in the cash flow
survival rate as the ratio of home value to account value increases, much more
than does the conventional strategy. Thus, the higher the ratio, the greater
the impact that comes from the active strategies as compared with the
conventional strategy.
Because
we hold the home value in our example constant at $417,000, ratios of home
value to account value that exceed 52 percent require lower account values than
the $800,000 value used above. Thus, for the calculations based on the 60
percent, 80 percent, 100 percent, and 120 percent ratios, we used account
values of $695,000, $521,250, $417,000, and $347,500, respectively.
Consequently, the initial withdrawaldollaramounts
for the 6.5 percent initial withdrawal rate were $45,175, $33,881, $27,105, and
$22,588 for those four account values, respectively.
The Impact of Higher Investment Returns
The cash flow survival probabilities determined with the use of
the 32-year investment return data were noticeably higher than those determined
with the use of the 37-year data. But the qualitative results were essentially
the same—with each investment return data set, the active strategies yield
substantially higher cash flow survival probabilities than the conventional
(reverse-mortgage-last) strategy.
Figure 6 is indicative: the cash flow survival probabilities are
shown for a 6.5 percent initial withdrawal rate for eight different situations.
The upper four lines show the results of the coordinated strategy using the
32-year investment return data and the 37-year investment return data, each
with the current expected rate and the applicable mean expected rate. It is
obvious that the 32-year data yield greater cash flow survival probabilities.
In fact, the 32-year data reflect investment returns sufficiently higher than
the 37-year returns in that they bring the 30-year cash flow survival
probability almost to 90 percent (and exceed 90 percent when the current home
value limit of $625,500 is used instead of the pre-2009 limit of $417,000).
The lower four lines show the results of the conventional
strategy, also using the 32-year data and the 37-year data, each with the
current expected rate and the applicable mean expected rate. The
reverse-mortgage-first lines have been omitted, simply for clarity. (As in the
previous figures, the reverse-mortgage-first lines would be very close to the
coordinated lines.) And again, the 32-year data yield greater cash flow
survival probabilities.
It is noteworthy that the disparity between the results of the
active strategies and the conventional strategy is somewhat greater in the case
of the 37-year data than in the case of the 32-year data. This is evident in
Figure 6, where, for example, the spread between the second and seventh lines
is a bit greater than the spread between the first and fifth lines. This
disparity also holds true with the other initial withdrawal rates. It suggests
that the active strategies for using the reverse mortgage credit line are of
somewhat greater value (relative to the conventional strategy) when investment
returns are weak than when they are strong.
Effect of Certain Safeguards
The authors are aware of the innovative work of Guyton (2004)
and Guyton and Klinger (2006) in the area of enhancing retirement income
survival probabilities. Therefore, we thought it would be interesting to see
how techniques similar to theirs could be used in conjunction with the reverse
mortgage strategies we have studied. We focused on “withdrawal rule 2” plus the
inflation decision rule, both of which are used by Guyton in the 2004 paper.
Under
withdrawal rule 2, “there is no increase in withdrawals following a year in
which the portfolio’s total investment return is negative, and there is no
make-up for a missed increase in any subsequent year.”17Under the inflation decision rule, “the maximum inflationary
increase in any given year is 6 percent, and there is no make-up for a capped
inflation adjustment in any subsequent year.” For simplicity, we call the
combination of these two rules the “safeguards.” Incorporating the safeguards
into our model significantly increases the cash flow survival probability with
both the conventional strategy and the active strategies.
Figure 7 shows that, with a 6.5 percent initial withdrawal rate,
the safeguards increase the 30-year cash flow survival probability when the
active strategies are used from just above 70 percent to nearly 90 percent.
(When the current home value limit of $625,500 is used instead of the pre-2009
limit of $417,000, the safeguards increase that probability from 80 percent to
more than 90 percent.) The safeguards also increase the 30-year cash flow
survival probability when the conventional strategy is used from about 40
percent to about 55 percent. Thus, the safeguards give approximately the same
boost to the conventional strategy as to the active strategies. The results of
incorporating the safeguards into the model at other initial withdrawal rates,
and other expected rates, are similar.
Residual Net Worth
After reviewing the results of the calculations and analyses set
out so far, the reader may ask whether the greater cash flow survival
probabilities that result from the use of the active strategies come at the
cost of lower residual net worth. We define the term “residual net worth” as
the value of the retiree’s portfolio plus the equity in the retiree’s home at
the end of the period in question. The equity in the home is the value of the
home minus the cumulative reverse mortgage debt, including accrued interest.
This issue is important to the many retirees who, in addition to
their primary concern for continuing cash flow throughout their retirement
years, have a bequest motive or concern about late-in-life needs.
Our
model includes a provision for calculating the residual net worth for each of
the three strategies; it also calculates the differences of those quantities
between each pair of strategies. When only the differences of the residual net
worth are used, the value of the home subtracts out, leaving only the differences
of the account values and the differences in the accrued reverse mortgage debt.
We define this as a positive difference if, at the end of any trial, the
residual net worth of the coordinated strategy exceeds the residual net worth
of the reverse-mortgage-last strategy.18
When the percentage of trials with positive differences is
greater than 50 percent, it indicates that the residual net worth is more
likely than not to be higher with the coordinated strategy than with the
reverse-mortgage-last strategy.
Without setting out a detailed display of these results, we note
that, for initial withdrawal rates from 4.5 percent through 7.0 percent, we
find positive differences in 67 percent to 75 percent of the trials. Thus, in
this range of initial withdrawal rates, the choice of an active strategy rather
than the conventional strategy is between two and three times more likely to
result in a positive difference in residual net worth than in a negative
difference.
Conclusions
We have considered retirement income in the classic mode of
constant purchasing power (except where the safeguards are invoked) over
periods of up to 30 years. The income sources we have considered consist of a
securities portfolio plus withdrawals from home equity by means of a reverse
mortgage credit line.
We have focused on cases in which the initial withdrawal rate
exceeds the so-called safemax rate of approximately 4 percent of the initial
portfolio value. In those cases, particularly in the range of initial
withdrawal rates between 5 percent and 6.5 percent, we have found substantially
greater cash flow survival probabilities when the reverse mortgage credit line
is used in either of two active strategies rather than in the conventional,
passive, strategy as a last resort. We have also found that use of these active
strategies is likely to result in a higher residual net worth after 30 years
than the use of the conventional strategy.
Endnotes
1.Brandon,
Emily. 2011. “How to Retire on Social Security Alone.”U.S. News & World Report(May
16).
2.Because
the retirement accounts are generally invested in portfolios of securities, and
because our analysis is based on the behavior of securities portfolios, the
terms “account” and “portfolio” can be considered interchangeable in this
context. In the case of a retiree taking withdrawals from a pre-tax account,
such as an IRA or a 401(k) plan, the retiree’s expenses will include his or her
income taxes.
3.See,
for example: Bengen, William. 2006. “Sustainable Withdrawals.”In Retirement Income Redesigned,
edited by Harold Evensky and Deena B. Katz. New York: Bloomberg Press.
4.There
exist a small number of financial products similar but not identical to reverse
mortgages. These include, among others, “NestWorth” and “FirstREX.” The
analysis and computations set out in this article are based explicitly on
reverse mortgages. However, the results, at least qualitatively, also apply in
situations in which other such financial products are used to supplement
withdrawals from the account.
5.See,
for example: Lieber, Ron. 2011. “Reverse Mortgages Here to Stay.”New York Times(June 25): “[Reverse
mortgages] will almost certainly become a necessary last resort for a nation
full of increasingly strapped people.” See, also: Quinn, Jane Bryant. 2011.
“Picking the Right Options.”AARP Bulletin(May):
“And don’t take a reverse mortgage in your 60s. Save these loans as a last
resort, for money in your older age.” As another example, see: Osterland,
Andrew. 2011. “The Retirement Tool Advisors Love to Hate.”Investment News(April 11–15): “‘Your
home should be the absolutely last asset you tap,’ said Joseph Duran, chief
executive of United Capital Financial Partners Inc.” See also: Pond, Jonathan.
2010. “Retired and Loving It!”AARP Magazine(May/June):
“You know your money will last when...you won’t need a reverse mortgage until
age 80 or later. These costly deals are best viewed as a late-in-life trump
card to keep you in your home.”
6.There
is a minor modification in certain cases when the investment performance was
positive: if the dollar amount of the account’s positive return was less than
the withdrawal amount scheduled for the next year, only the amount of the
positive performance is taken from the account, and the remaining portion of
the scheduled withdrawal amount is taken from the credit line. Also, of course,
if the investment performance was negative but the reverse mortgage credit line
has already been exhausted, the entire withdrawal will come from the account.
7.The
algorithm described here, with its embodiment in a computer-based system for
advising retirees on withdrawal amounts and sources, is the subject of a patent
issued to the authors November 8, 2011.
8.We
recognize that inflation figures for any year tend to relate to those of the
preceding years, rather than vary stochastically. We plan to further refine our
model and our analysis to reflect that fact.
9.It is
worth noting that in some of the repetitions the portfolio survives with very
substantial value at the end of the 30-year period, and in others the portfolio
survives with very little value at the end of the period.
14.Because
the expected rate appears only once in each 30-year trial, our model does not
Monte Carlo simulate the expected rate. By means of a set of tests, we have
determined that there is no significant difference between the cash flow
survival probability results of using a single expected rate throughout a
series of trials and the results of Monte Carlo simulating the expected rate
throughout the same series with a normal distribution around the same expected
rate.
Another parameter relevant to the reverse mortgage, but less directly relevant
to cash flow, is the so-called “current rate.” The current rate is determined
each year and is the short-term interest rate (typically the one-year Treasury
rate or the one-year Libor rate). It is used every year for two purposes: (1)
it determines the rate at which amountsalready
drawnfrom the credit line accrue interest that year, and (2) it
determines theincreasein the
amount still available from the portion of the credit linenot yet drawn. The second purpose does
affect cash flow to the retiree. This parameter is Monte Carlo simulated in our
model.
15.This
value, although just part of an illustrative example, is chosen because it is
very close to the average value of the “investable and disposable assets” held
by the members of “Group 3” (those who have a “paid planner and a comprehensive
written plan”), age 65 and over, as described in the 2008 FPA and AmeripriseValue of Financial Planning Study: Consumer Attitudes
and Behaviors in a Changing Economy, conducted by Harris
Interactive. (The average is computed without the one outlier who reported
investable and disposable assets of $20 million or more.)
16.At
least through December 31, 2012, $625,500 is the maximum home value that can be
taken into account in any reverse mortgage that can be drawn upon in the form
of a credit line. Therefore, home values larger than that limit, although
theoretically increasing the ratio of home value to account value, in practice
do not increase the ratio.
17.We
could not use the modified form of the withdrawal rule described in the 2006
work, because that rule involves the withdrawal rate at the time of each year’s
withdrawal. That rate is equal to the amount of the withdrawal divided by the
value of the account. Our three-spreadsheet model has the withdrawal in any
given year coming from different sources on the different spreadsheets, and
hence the value of the account in any given year (except the first year)
generally differs among the three spreadsheets. Therefore, if we were to use
the modified withdrawal rule, the amounts of the withdrawals (in some years,
and hence cumulatively) could be different among the three strategies; this
would be inconsistent with our approach to the comparison of the three
strategies, under which the withdrawal amount is the same for each strategy.
18.It is
important to note also that therangeof
likely outcomes of the difference of residual net worth, at the end of 30
years, is extremely wide.
