“Cost of Living Rider? Or-HECM HELOC Growth Rate?”

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

Copyright 2020 Daniel J Turner All rights reserved.

 

Today, I want to discuss the FHA HECM HELOC and Tenure payments with regard to the use of the “Tenure” and “Term” features in coordination with a retirement income strategy. Both of these programs provide values and differences within a well established and soundly based program in the retirement planning world.

 

The first participant is the oldest financial planning income tool in the business. It is the  Single Premium Immediate Annuity (SPIA).

BASICS

I am remembering that a Life insurance company provide 2 substantial functions:

1. It converts income streams into lump sums;

2. It converts lump sums into income streams.

 

A SPIA converts a lump sum into an income stream with specific contractual guarantees.

1. The Annuitant cannot outlive the income.

2. Policy benefit riders are available to provide different dimensions of security or values if death is premature (Seriously-what death ISN’T “premature”? 😉

 

The issue is that when an annuity payout is being structured, there is a baseline value for the monthly income. Any modifications the Retiree desires has a cost. However, it isn’t a premium paid for benefits received, it is a reduction of the monthly income proportional to the value received. Benefit choices will reduce that monthly income sum.

As an example, Let’s assume The Annuitant want Life only income. That “choice” will provide (lets say) $1,000/month.

But, what if he’s married? (Most men die well before their wives because they want to 😉 (an old joke) Providing the Wife an income for her life will reduce the $1,000/ month to a lower payout (say $850/month, but when HE dies? SHE will continue to receive $425/month (called “Joint and 50%” Annuity) or if chosen, a Joint and 2/3rds Annuity ($561/month for her life). “Pension Maximization” is based upon taking the Life-only income option, and buying life insurance to provide a lump sum for the Widow that may be annuitized for her benefit for a continued life income stream that would (hopefully) be higher than the annuity payout provided by the Pension.

Another relevant consideration is the “Cost of Living Adjustment” (COLA) rider. It provides a lower payout for guaranteed increases of the income stream based upon the inflation index. If inflation is 3%, the Annuity payout would increase by 3% per year. This is typically capped as a way for the insurer to protect itself from hyper inflation.

This is an example of how an insurance Company mitigates its exposures by adjusting the payout downward for the considerations made by the Borrower. While there is nothing wrong with this in theory or in practice, the bigger points are;

~Annuities work best with older ages

~Annuity payouts are not reversible; once funded, they payout for the life of the annuitant or contract (e.g. Life with 10 yr Certain)

~If Medicaid Spend down is involved with a retirement, this income stream may end up being spent on long term care expenses when suspending it (which is impossible) could be a more practical option, and preserve wealth.

~Most retiree’s are reluctant to let go of the capital needed to create the income streams required for comfortable retirement in spite of the comfort and assurance the guaranteed income provides.

~All other annuity selections and structures are less than the Life-only selection.

 

The second participant retirement income planning tool at our disposal is the FHA HECM HELOC.

 

How does a Reverse HECM HELOC integrate with this scenario?
Very well (I’d say!)

1. While this is not a hard or fast rule, the tendency is that mortgage rates are double the inflation rate. (IOW, 3% inflation will typically and somewhat historically be 6%)

2. A HECM HELOC has a growth rate. It is guaranteed to add new equity to the HELOC for the life of the loan. In fact, it is guaranteed for 150 years from the date of birth of the youngest Borrower.

3. The HECM HELOC payout baseline is not “Life only”. It is a 100%/100% payout. The COLA value is literally twice the average contractual guarantee provided by the insurance company.

4. The HECM HELOC payout is not taxable. Nor does it raise the AGI. In fact, it’s not even reported to any particular body or institution.

5. The HECM HELOC payout is reversible; if the Retiree wishes? They can suspend, increase, reduce the monthly income stream. While this may interfere with the life guarantee provision (if they increase the income too much over the original base income sum)

6.The HECM HELOC payout is NOT “income”. It does not get added to the threshold income that triggers taxes on Social Security.

7. It is to the Client’s best interest to keep funds working as long as possible. Using Term or tenure to meet income needs allows continued pportfolio growth.

8. In down markets using “Bucket”, “Flooring”,  or “Systematic Distribution” asset planning, the payments to the Borrower may be stopped in down markets and use the Term provision to substitute equity for portfolio distributions as losses. When/as markets and portfolio values recover, simply stop the payment stream and resume the portfolio distributions.

 

This is how a Planner would approach this-

1. FUNDING this as soon as possible (age 62) is IMPERATIVE as the HELOC will have several years to add new equity that may be converted to income sooner or later. DELAYING this does not provide better alternatives or outcomes.

2. When income (or additional income) is needed, the Planner may simply convert part of the equity line into income stream. The choice may be to use a “Term” payout (e.g. covering the years from early to late 60’s to improve Social Security payouts), or convert to “Tenure” payments for life time income streams.

3. As they age, more funds may be required to meet monthly income needs. More of the HELOC balance may be converted, or kept as a reserve for emergencies. Additional funds may be kept in the portfolio to grow future values instead of converted to income stream and lost from portfolio growth.

4. Finally, If more income is needed, portions of the portfolio may be liquidated and PAID INTO the reverse (Exercise caution to make sure the loan is not paid off as it will close the loan) just as any lump sum payment. This money will immediately become available for use, and can be converted into even MORE income Tenure or term payouts. The payment INTO the HECM may pay mortgage interest which will trigger a 1098 that can be used to offset the income tax responsibilities brought from liquidation (particularly qualified funds).

***Strategically, the SPIA may or may not have higher payout values. A comparison should be done to make sure correct advantages are used. In my opinion? using the SPIA later in life makes more sense. Using the home equity earlier is helpful in delaying portfolio distributions to the last possible time frame, increasing the age = increases the payout and requires less capital from the portfolio.

Final Thoughts

First, it is very important to note the “Fixed Rate FHA HECM is useless in the planning effort. In fact, a recent study class offered by the American College correctly noted the “FHA (Fixed rate) REVERSE did not offer any kind of inflation protection”. This was an astute observation. There is no growth or inflation protection because there is no line of credit available. In fact, when the fixed rate is chosen? The Client immediately forfeits the equity (approximately 20-25% of the appraised value!) that could have been their line of credit. Also, any selection must be taken at the time of the loan closing. Lump sum, tenure are all that is available. So, when used in that scenario to provide income? No. There is no protections against inflation. As mentioned above? The HELOC has both equity growth at the mortgage rate of velocity with guarantees, and more equity may be added to the existing payout at any time to accommodate an inflationary hedge of protection.

Second, I believe that due to the overwhelming reluctance of Planners to use Home Equity via Reverse mortgages, there develops a “square peg, round hole” mentality that compels the Planner to use a tool who’s time has really not arrived. Those funds would be better off left in the investment side to grow future value. Portfolio’s don’t do well when you pull large sums to purchase an immediate income annuity when the Client could be using home equity payouts instead. When we consider the statistical fact that for every $100,000.00 in investment savings there is $2-300,000.00 of “available” home equity? “NOT using the Tenure feature is both troubling and questionable to me.

Finally, the FHA Reverse HELOC has long been considered “the Loan of Last Resort” until 2012 when Barry & Stanley Sacks (PhD’s and CFP’s) published their study in the “Journal of Financial Planning“ which led them to making their presentation to FINRA (the regulating body for the Financial industry). FINRA was compelled by FACT to reconsider their position regarding the FHA Reverse Mortgage HELOC plan and recanted their statement of it being “the loan of Last resort”. The Sacks’ brothers proved that waiting to get this loan was the worst tactic possible as it simply didn’t allow the program to mature its values for future use. This also perpetuated the impression that the program has but little practical use (similar to making the judgement that frogs will turn deaf when you cut off their legs). Many of the most-useful ways one can use a reverse in planning are based upon the development of the debt and the HELOC. Time improves values, and enhances Retiree options.