“You’d better not die” was a friend’s response after reading this article.
A major lender is “… pitching … the idea … to use the [adjustable rate Saver] credit line to help meet living expenses in the early years of retirement in order to delay filing for Social Security benefits as long as possible, thereby increasing monthly payments later and enhancing income in advanced age,” or so Mr. Mark Miller alleges in a December 8 article at Registeredrep.com.
Is this generally sound financial advice or a suitable use of HECM proceeds?
Significant Methodology and Assumptions
Examples will be used to demonstrate the strategy. So the examples can be presented as quickly as possible only minimal assumptions are presented in this section. To avoid a distorted, incomplete, or incorrect impression, reading the assumptions following the examples is highly recommended.
Because there are many unknowns, this evaluation does not consider 1) Congressional increases inSocial Security benefits, 2) investment opportunities with excess cash, 3) income tax implications, 4) extenuating circumstances, and 5) other factors. In essence examples will be looked at as if in a vacuum.
It is assumed that the weighted average effective note interest rate is 4% in all examples. Except as otherwise noted, the total costs financed will be assumed to be $2,000. Obviously the greater those costs are, the worse the results will be from using the strategy.
The borrower in the examples is a widow whose Social Security benefit at full retirement age of 66 is $2,000 per month; her monthly benefit at 62 will be $1,500 and $2,640 at 70. The monthly benefit will only be $2,480 at 69. The borrower is assumed to be fully retired the month before becoming 62 with no earned income for Social Security or Self-Employment tax purposes thereafter.
The first two months of tenure payments will all be received thirty-one days after the widow turns 62.
Here are four examples.
Example 1—Based on the information above, if the borrower takes $1,500 in tenure payouts for the full eight years until reaching age 70, the balance due on the AR HECM will be $182,279. If the borrower uses the amount of Social Security benefits in excess of $1,500 (or $1,140) to pay down the AR Saver each month after reaching age 70, it will take about 273 months or about 23 years to pay it off. So if the borrower dies before reaching age 93, the borrower would have been better off just taking $1,500 per month of Social Security from age 62 forward.
Example 2—Using the same information as in Example 1 but increasing total upfront costs financed to $9,000, the AR Saver balance due is $192,877 at age 70. The repayment period jumps up from just under 23 years to over 25 and one-half years. As expected this scenario is worse.
Example 3—This example is the same as Example 1 except the borrower has decided to work until age 66 and will not need any Social Security benefits until reaching that age. Because of her higher earnings she will be required to return all of his Social Security benefits between ages 62 and full retirement at 66 so she decides to delay AR Saver origination until reaching age 66. She wants to take the equivalent of full retirement age benefits upon turning 66 or $2,000 per month in tenure payouts. At age 70 she will take her full $2,640 per month benefits.
When the widow reaches age 70 her AR Saver balance due is $109,498. Using the $640 amount above the $2,000 she receives to repay the HECM, it will take her 313 months or just over 26 years to do that. So if she dies before reaching age 96, the use of the HECM was not economically sound. If she dies after reaching 96, it may have been a good idea, but was it worth the risk?
Example 4—Using the same information as Example 3, the widow has decided to wait until 69 to start taking her benefits. Since the benefits will only be $2,480 per month, she will only have $480 per month to pay down her Saver. Since she will only be receiving the $2,000 per month in Saver payouts for 36 months, her balance due at age 69 is only $80,477. At a repayment rate of $480 per month, it will take 25 years to pay off the HECM. Thus if the widow dies after age 66 but before age 94, will the additional benefits be worth the risk?
There appears to be few instances where this strategy helps. To show some benefit, one would have to come up with some very unusual fact patterns. Could we dream some up? Most likely but demonstrating when it could work is something those who actually promote this idea should present. If Mr. Miller is right, we would like to know why the strategy is being generally recommended.
Even if the borrower receives much less in tenure payouts than $1,500 at age 62, the borrower is missing out on the Social Security benefits which will not be made up at death, i.e. there is only a meager Social Security death benefit. Social Security benefits payouts not received due to failure to elect the benefit start date are not vested and thus are generally not recoverable. So in essence, the borrower is depriving her estate of those benefits and any earnings from the investment of the related cash until the difference in the higher Social Security benefits exceed the lost Social Security benefits plus lost earnings.
Some believe that the estate could be protected by life insurance. The trouble with that theory is the cost of the strategy would rise as well.
While deferring vested defined contribution plan (such as a profit sharing plan, 401(k), money purchase plan, and targeted benefits plan) distributions can be beneficial since they are vested, the same cannot be said for Social Security benefits which are not. In some ways delaying Social Security benefits can be riskier than seniors investing in deferred annuities with their HECM proceeds. As the old saying goes: “It all depends.”
To those who support the strategy, your comments are greatly appreciated. This forum is a place to exchange ideas on topics, not attack the promoters of ideas which may be in dispute. Different views are welcome.
Further Assumptions and Other Information
In presenting an evaluation of a financial strategy the evaluator should provide the assumptions used,the facts and circumstances considered, and other relevant, significant factors utilized. The goal of the examples was not to find situations when the strategy might work but rather to demonstrate how strategy is generally flawed. Thus unless the promoters can reasonably justify how the borrower or the circumstances of the borrower are sufficiently different to warrant the strategy, the promoter could be advising the strategy at the financial peril of the prospective borrower. Lenders and originators should take particular care in recommending the strategy in states like California where the fiduciary standard of care generally applies to NMLS licensees.
The only HECM used in the examples was the AR Saver since that is the product presented in the article by Mr. Miller. If the strategy is valid, the AR Saver definitely seems to be the preferred product unless other needs exist or the value of the home is insufficient to support the strategy.
The weighted average effective note interest rate of 4% seems reasonable based on the estimated length of the loan in the examples. If the actual rate turns out to be higher, the potential harm to the borrower from using the strategy could be greater and vice versa.
The borrower was assumed to have moderate wealth but is concerned about outliving her resources.Over the last twenty years she has worked with her financial planner so that she could live up to her expectations in retirement as long as she obtains her monthly Social Security benefit (or the cash equivalent) at age 62. The widow would also like to maximize her estate to the extent she does not need to maintain her retirement objectives. Her retirement financial plan becomes fully operational when she turns 62 and will not change except to adopt the replacing strategy promoted by the HECM lender starting on the day she turns 62.
The examples were based on the simple principle that cash can replace cash. So whatever the SocialSecurity benefit is at 62 will be replaced by AR Saver tenure payments of an equal amount.
Upon reaching age 70, the tenure payments will cease. Because the borrower cannot invest her money at a rate which will generate more income after tax than 5.25%, she will pay down her HECM starting at the time she actually receives her first Social Security benefit and the amount of the payment will be the difference between her actual benefit and the benefit she would have received if she started taking her benefit at 62.
Normally the reduction for starting Social Security benefit payouts before reaching full retirement age is 0.555% for each month such benefits start before reaching that age; however, the maximum reduction is limited to 25%. The monthly benefits at age 62 will be assumed to be $1,500 per month (or 75% of$2,000, the benefit at full retirement age of 66). Following full retirement age, any delay will increase the benefit 8% per year without compounding until reaching age 70; thus the monthly benefits at age 70 will be 132% times the monthly benefit at full retirement age. In this case she will receive $2,640 monthly starting at 70 if she delays taking any benefits until reaching 70. That is $1,140 higher than the benefit would have been at age 62, ignoring and excluding all congressionally granted cost of living adjustments (COLA).
James E. Veale, is a CPA, MBT and is a Senior Vice President at Security One Lending, Inc.Email This Post Print This Post
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