“Strategic Retirement Tax Planning With a Reverse Mortgage”

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

Copyright 2020 All rights reserved. Use by written authorization only.

 

What comes to mind when you read a title to an article stating “Strategic Tax Planning With a Reverse Mortgage”? Hopefully, a nice, clean, white canvass that can be used to paint a new picture of retirement values.

As tax avoidance is a relevant and critically important aspect of retirement income management, so is the use of the FHA HECM HELOC reverse mortgage for ANY Client who owns their home and especially for those who have remaining balances on their mortgage. Recently, a friend of the American College (Shelly Giordano (Co-Founder) with the “Academy For Home Equity In Financial Planning” wrote an article that was posted in “Reverse Mortgage Daily” (Sept 1, 2020) titled “The Street:How Voluntary Reverse Mortgage Interest Payments Impact The Loan”.

In this article, she points out the cause and effect of doing the unthinkable-actually making voluntary mortgage payments against the standing debt! I mean, how CRAZY is THAT!?!

The point of this article is to expand upon her article, and “show off” (a little bit) of the capacity of this incredibly adept program for Seniors.

 

THE ISSUE

“Required Minimum Distribution” (RMD)  is the thorn in the side of  of any portfolio manager. It compels income to be distributed and taxes be triggered regardless of whether the Client wanted income. It is a forced distribution. Just as dollar-cost-averaging is the consistent purchase of shares or unit values; the subjection of qualified funds to distribution via RMD averages the forced distribution to taxation without regard to the needs of a retiree.

 

As tax avoidance is a relevant and critically important aspect of retirement management, so is the use of the FHA HECM HELOC reverse mortgage in this plan.

 

ISOLATING THE BASIC RULES

***It is important to note that the following strategies defy most Planners current paradigm models of using a reverse as “the loan of last resort”. This is a shift in tactical thinking that establishes the point YOU KNOW if a Client is going to suffer RMD when they first meet with you. THAT is the best point to dig the well and initiate the reverse mortgage. These strategies are the MOST efficient when the reverse is set up and established in the following points:

1. Youngest Borrower is age 62. Under age Borrowers cannot use equity without refinancing the debt after the death or separation of the eligible borrowing spouse. A lot of unfortunate things can happen in retirement between 62 and 72 (including) the death of the Secondary (older) Borrower.

2. The HECM PAY-OFF with HELOC is the ONLY reverse model that will work with this in any convenient format. The “FIXED” rate can work, but requires a refinance to trigger the required 1098, and subject to FHA rules regarding refinance, and ratios that must be met for both cash value and increasing the maximum claim limits, this just may not be possible. Additionally, any equity growth is locked into the loan structure as there is no line of credit feature to a fixed rate reverse. The Fixed Rate plan also denies the Borrower substantial additional equity the HELOC plan includes.

3. No Payments or contributions to the debt to maximize the debt interest accumulation. If the home is a max claim loan and no HELOC value is present? The ideal would be to allow the debt to grow without the HELOC. At age 72, simply transfer funds to pay down the interest and Mortgage Insurance Premium (MIP) component. This will create a dollar-for-dollar increase and presence of the self-funded credit line, and allow the credit line to create ongoing tax deductions. This will be explained more deeply below.

4. Margins must be set as high as possible to add substantial interest debt to the mortgage. If you work with a Loan Officer who has the RICP designation, you can be well assured the structure will be done correctly.

***Due to the recent change in the MIP premium structure, the present Annual MIP is now 1/2 of 1% (0.50%) of the accumulating debt.

 

DOING THE MATH

Having set up the reverse to these parameters, and allowing the primary debt to accumulate negative amortization, at age 72 the Client may now execute established procedures that do not require the withdrawal of monies from established qualified accounts and greatly eliminate the tax liability.

Step 1. Review the most recent reverse mortgage monthly statement By using some basic math, one may determine the amount of total debt above the initial borrowed sum.

Example-

Loan Balance:……………………$604,700.00

Original Principal Limit……..  410,456.00

Current Principal Limit:……..  655,406.00

Net Principal Limit:……………  49,155.00 (available credit line)

604,700.

-410,455.

$194,244.00 is the total sum of MIP and interest accrued on this account. To get the exact sum of interest, the Borrower must call the servicing company listed in the top right of the statement. With the Borrower’s presence, permission may be granted to release information regarding the loan content to determine the amount of available interest. This is needed to calculate how much may be withdrawn from the Qualified account. That sum must match the dollar amount of mortgage interest paid, or part of the withdrawal may be subjected to taxation. Depending on the age of the reverse, the MIP will likely represent under 20-25% of the balance. In this case, the Planner may look at withdrawing approximately $310-320,000 of Qualified assets to roll into a ROTH or other vehicle without taxes. While it MAY be done all at once, I would advise a staged approach. Even though the law says that “If you pay mortgage interest under $750,000 of principal debt, You may deduct it against earned income” there is no reason to stir or agitate IRS folks just to prove what you’re doing is legal when you can do this one bite at a time.

 

HOW TO DO IT

Once the number is determined, (in this case), the Borrower may withdraw the $49,155.00 and immediately PAY IT BACK to the Lender. Once the lender receives the check, it is now a mortgage PAYMENT and not a return of principal. This will be applied as against all MIP FIRST; and once MIP is entirely paid off, it is applied against mortgage INTEREST SECOND. This is what triggers the 1098. It is important to be careful and NOT pay off the principal DEBT with the HELOC as it becomes HELOC principal and may not create deductible interest in the manner the primary mortgage debt does.

Upon the payment to the debt, the debt is paid, the balance is restored to the HELOC dollar for withdrawn dollar, and this process may be repeated any number of times until the sum of deductible interest is created. Again, a reminder-doing this in stages will allow greater long term continuity for future tax service needs.

***IMPORTANT NOTE: using up all the interest is something to consider. It is important to point out the net result of this transaction is the same regardless of the times it is done. There is no reduction of debt, no increase in HELOC balance. Everything ends the same way it began. It’s very similar to placing your fist in a bucket of water. The transaction DOES (however) actually PAY the expenses of the loan, and actual monies are distributed to FHA and the Investor, and will legally create the 1098 needed to wash the taxation responsibilities from the Qualified distribution.

Another way to do this would be to withdraw funds from an “Emergency spending account”, or the portfolio itself. Since the timeline on this transaction is approximately 2-3 weeks per transaction (more than one transaction may be needed to consume all of the interest and create the desired 1098 mortgage interest paid balance), I would urge this to be done any time from July through November of the SAME YEAR as the Qualified plan distribution. Waiting longer may complicate issues with getting the right monies used to trigger your 1098 or there may be other complications with processing the deposits and/or withdrawals.

 

FINAL THOUGHTS

Of course, the outcome of this transaction in either method of using the credit line or available funds is a substantial 1098 that can be used to offset tax responsibilities for RMD (or, earlier) distributions.

Additionally, once this is converted and used, the debt balance is still available for the Borrower & Planner to use in other ways (specifically) to defend assets from the Medicaid Spend down rules. If one of the Spouses needs institutional Long Term Nursing Care, simply liquidate the investments and pay DOWN (DO NOT PAY “OFF”) the reverse mortgage, and the deposit will reduce the debt, and increase the line of credit simultaneously. Once this is done, any interest paid may be used to offset taxes incurred from the mortgage debt pay down. This will also turn the entire debt (except for the $,1000.00 recommended minimum loan balance) into usable HELOC that will grow on a guaranteed basis of 100% of the annual MIP and Interest rate based upon the HELOC balance daily accumulated annually. Presently, this sum is approximately 3.5% new equity added annually. The HELOC is guaranteed for the 150 year (home) residency of the Borrowers youngest DoB, and cannot be reduced, cancelled, or suspended. Of course, the reality is that Congress may eliminate the capacity to deduct interest altogether. Even with that loss, the values and protections provided by this program make it a necessity for future Client success and prosperity. There are myriad ways a Client may benefit from the FHA HECM HELOC program but it will be quite impossible if you don’t teach them about it.

 

***As paying off 100% of the mortgage balance in a reverse will close the account and all other possible advantages will be lost in lieu of refinancing the loan all over again and being subject to new HUD rules for this plan that may make obtaining it impossible. BE CAREFUL. Payoffs are irrevocable.

 

Finally, Remember also in your strategic planning that the Reverse HELOC cannot be helpful in this scenario if you’re waiting for the Client to hit age 70-72 to initiate the loan program. There simply isn’t enough time to build up and bank the interest needed to accomplish anything. Starting the reverse at age 62 allows a DECADE for the debt to grow, and be substantial enough when the time comes to actually solve a tax problem. The reverse must be built and funded early in the retirement process, and (against your notions) not late in the process.

 

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