Using a Reverse HELOC vs. Immediate Annuity To Guarantee Monthly Life Income”

by Daniel J Turner NMLS#1016716; Geneva Financial LLC NMLS#42056

 

RETIREMENT INCOME PLANNING STRATEGIES

There are several strategies available in Retirement Income Planning to create a base income for retirement. This “base” income needs to be able to cover essential expenses like insurances, taxes, food, utilities, and other relevant non-discretionary expenses. Some of these may actually add value or purpose to life in retirement; some may not.

Typically, this base income is made of pension-like programs. Social Security is an example. A Defined Benefit pension is another.  Disability income from Workers Compensation or similar agency payout may also qualify for this conversation as what we think of as (dependable) lifetime income streams. Full or part time work may be there, but are not included in this conversation as they cannot be relied upon for the long term. I’m really specifically looking at LONG TERM LIFE Income with guarantees.

 

First, let’s look at the benefits and detriments to all other income streams mentioned above.

1, May be or become taxable. All income streams are aggregated at years end. All or most all income above the standard deduction are taxable.

2. Typically guaranteed for the life of the retiree. Joint payouts may be reduced initially or after the primary death.

3. Benefits are often reduced substantially (Joint & 2/3rds or 50% is common); SSI stops altogether.

4. Income streams cannot be stopped.

5. Income streams cannot be changed.

6. Income streams cannot be suspended.

7. Access to the principal sum is not possible once annuitization begins.

8. Unless alternative payouts are selected at the beginning, there is no refund of unearned principal (Life-only annuitization).

9. Mechanisms to offset this exposure will reduce the (high water) monthly income stream for the life of the annuitant. The premium paid for these protections comes as a reduction of monthly income.

 

REVERSE HELOC AS A STRATEGIC SOLUTION

On the other hand, one potential income stream that is almost ALWAYS ignored (the term “overlooked” would graciously imply that it’s actually on a Planner’s radar; it is not) is the Reverse Mortgage HELOC program. The HELOC provision of this program provides the Retiree several really important and valuable capacities, protections, and benefits…

1. The HELOC balance may be converted to an income stream (called “Tenure”, or “Term” depending upon choice of duration) at any age past 62 of the youngest Borrower (the Youngest Borrower must legally be a “Borrower” on the loan, and not merely an underage and protected spouse).

2. Some, Part, or All of the available HELOC line may be used. Unused balance will continue to add new equity to the balance at the renewed annual interest rate (plus mortgage ins MIP rate) until called upon.

3. Income streams for this benefit are FEDERALLY GUARANTEED for the life of BOTH occupants while living in the home.

4. If both Spouses fail to meet the 6 month + 1 day FHA occupancy requirement, the loan may be called. The family will have the ultimate say in the desposal of the home, but for the immediate part? The income payout is suspended and preserved for the Heirs. The total time for closing a reverse in this matter is 13 months. During this time period? NO penalties, late payment interest charges (other than normal accruing interest at the prevailing renewal rate), attorney fees, court fees, per diem charges, or any other charges are assessed against the loan balance. Additionally, don’t miss this critical point-The equity STOPS being paid to the Client instead of worthlessly continuing to be applied to Medicaid Spend down rules.

5. The “Tenure” payment is guaranteed for the lives (as mentioned), but unlike any other income stream? It can be (with Client’s written request)

a. amended. The amount initially offered may be changed at any time with written request to the Servicing Agent

b. reduced. The Borrowers may reduce the sum paid out after it initiates with written request.

c. suspended. The payout may be suspended indefinitely. If this is chosen? It may be reinstated at any time. If suspended? The HELOC balance becomes available to the Borrowers and continues to                 add new equity per day. If Client wants to resume? They may ask for more or less or the previous sum payout. Sums withdrawn from the HELOC balance will reduce the monthly income stream.;

d. increased. At any time, the Client may request an accelerated payout that may reduce the number of years they may receive funds depending upon the amount of increase.

e. stopped. The Client may terminate the payout at any time. The residual balance will remain in the credit line as immediately available non recourse equity, and continue growing at the prevailing                 mortgage interest rate.

 

STRATEGIC INCOME PLANNING WITH A REVERSE HELOC

Whether considering the initial construction of a “Flooring” income, or primary “Bucket” approach, or calculating the sum that may be withdrawn with the Systematic Withdrawal approach, the Reverse HELOC is a useful preliminary tool. I strive to make this point as most readers are under the deeply flawed assumption the Reverse mortgage is “the loan of last resort”. It is not. The truth is that the longer it is in force? The more useful and beneficial it is.

The obvious benefit for the Systematic Withdrawal strategy is to use the HELOC as a “hedge” or buffer against market corrections. This prevents the Client from taking price haircuts when each monthly withdrawal from the portfolio is under the original purchase price. Another significant point is the elimination of the mandatory mortgage payment means the Client needs less money each month. The Client spends less on worthless mortgage interest each month. The Client may be able to re-purpose the payment into a dollar cost averaging fund for growth for future financial needs or legacy. Since a non-recourse mortgage cannot “default” for non-payment, either the distributions may be larger, or less money is needed if the standards of life quality are being met.

But, let’s drill a bit deeper into this…when a reverse HELOC is established for a Client, it either eliminates a mortgage payment and/or creates a substantial HELOC balance equal to 55% of the home appraised value. This is available as “Cash at the Closing” or, may be refused and it becomes an immediately available HELOC line of credit in the first year, with a similar sum added in the 366th day from the funding date. With the Client now owning a fully funded “stand-by” HELOC? Rather than purchasing an early age life income annuity at age 62-65+ and forfeiting access and use of that substantial deposit, the Client may choose to set up a “Tenure” life or term payout that is tax free and won’t interfere or trigger taxes against SSI. This allows the purchase value to remain invested for total return. Another advantage to this technique is that using home equity first means a higher valuation when the eventual income annuity purchase is made later. Adding 10-12 years to an annuitant’s life can make a very substantial difference.  Rather than reducing the portfolio asset base, you’re able to double it over that period. Adding in benefit guarantees (5 yr, 10 yr certain, Return of Principal riders, etc.) that would normally reduce the monthly payout may be offset by the ten year age advance added to this strategy, and allow the annuitants to add recovery riders that may re-direct the remaining purchase price to the survivor.

The obvious benefit for the “Bucket” strategy is that Converting the HELOC to “Tenure” or “Term” payments for the life of the first bucket means slowing the bucket withdrawal or increasing the distribution, or setting the surplus aside for future use. During these low interest rate times, and possible adverse valuations from interest rate shocks, it is nice to know the HELOC is growing (current rate) at 3.25% or higher vs. returns for TIPS or I bonds. As long as mortgage rates are higher than Treasuries? This will remain a viable strategy. Even if the rates change? It is an easy process to withdraw the funds and reposition them back into their original portfolios, and with 3+% more equity than originally planned, without any surrender costs or broker/agency fees. The one drawback to this strategy is that the Planner cannot put ALL of the first bucket into the reverse (or, it pays off the loan and the account is closed which requires the Client to refinance into another reverse at whatever current programs are available at that time); but it can put a substantial amount into it (especially) as the debt grows. This capacity to add money to the HELOC and use it in tenure or term payouts during the first bucket payout means seriously reconsidering other more market adverse strategies for higher returns in a federally insured access account. Depending on the performance of the first bucket, or circumstances of the Client (health, finance, grand children, etc.) the savings can only be best used if they exist in the first place.

The obvious benefit for the “Flooring” strategy is that the first real step to building a flooring strategy involves delaying social security and reducing expenses. By establishing the Reverse HELOC as soon as possible, the Client may calculate an age 62 SSI payout and then request that sum be paid in tax free home equity to age 70. This is best done with the “Term” payout; not the Tenure (which is mortality based upon the youngest Client). If we are refinancing a large mortgage balance and little or no equity remains for the Client to use (at the least) the mortgage payment may be considered an element of reducing expenses and that payment may be repurposed into 2 possible efforts:

1. Paying down the mortgage on a voluntary basis. This will increase the HELOC value dollar-for-dollar and be readily available for use in retirement, or expense shifting, or any other good reasons. Saving it means establishing a valid “Emergency fund” without competing with the mortgage payment, income taxes, and the urgent need to save funds simultaneously.

2. Invest the mortgage payment into any rational investment on a dollar-cost-averaging basis. Look at a typical 4 yr old 30 yr mortgage: payment is $2,000/mo for P&I; and the P represents $500; the I represents $1500. By investing the same $2,000 into your selected investments? There is no more wasted money on mortgage interest 100% of the investment is actually working for the Client vs. 25% in the mortgage actually paying down the debt. The Client is literally increasing the efficiency of the payoff effort by a factor of 4. Meanwhile, $2,000/mo represents over 35% of the Client’s monthly debt-to- income ratio (DTI). The Reverse just made it go from a mandatory threat to retirement to a choice of redistribution opportunities.

In circumstances when there IS a substantial line of credit available, you may discuss the idea of delaying SSI to gain a substantial advantage. Or at any point, convert some, part, or all of the HELOC balance to “Tenure” income, and help base up that floor income. Rather than using savings and/or investment assets to purchase an immediate income annuity at a substantial age disadvantage? That money can remain invested for the future benefit of the already strapped retiree, or used to purchase an immediate annuity now, or later, or both, or wait for future years to see what inflation does or simply help handle unforeseen circumstances (daughter and 3 kids now live in the basement, etc.). It is also possible to use the HELOC Tenure to cover credit card payments and other relevant expenses by cost-shifting from the checkbook to the HELOC and letting non-recourse equity do the rest. Additionally, as the mortgage debt grows, being able to shelter investments from Medicaid spend down is an imperative consideration. It is remarkable how no one seems to notice this point-MEDICAID will allow a Client to make debt (mortgage) payments. Since the loan is non-recourse, and all contributed funds become un-attachable by Medicaid and cannot be forced into debt service, and will continue to grow at prevailing mortgage rates and may be legally used by the Client so sustain themselves during this period. After the client recovers or passes on, the surviving Spouse may repatriate the equity remaining back to investments, or increase tenure income or any other idea (generally) that comes to mind.

***It is also extremely important to point out that NONE of these strategies can be helpful if the Client waits for later in life to start their Reverse HELOC. Earlier in the planning process is FAR better than later.

Regardless, the bottom line says it all-using a Reverse HELOC and adding home equity adds security, stability, safety, and creates great choices.

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