Reverse Mortgages and the Holy Grail of Retirement Planning

Retirees face many challenges in retirement, but perhaps none is greater than the risk of outliving their savings. As research in recent years has shown, reverse mortgages can be the holy grail for some retirees’ financial plans.

For retirees, maximizing higher fixed costs in retirement increases their exposure to sequence risk by requiring a higher withdrawal rate from remaining assets, writes Wade Pfau, professor of retirement income at The American College, in a recent Forbes article.

Through the strategic use of a reverse mortgage, particularly a Home Equity Conversion Mortgage (HECM) line of credit, retirees can mitigate such risks of depleting their investment portfolios and locking-in losses at inopportune times.


“The holy grail for retirement income strategies is improved efficiency: being able to spend more while preserving a larger legacy,” Pfau writes in the Forbes article. “The synergies created by strategic use of an HECM line of credit can support a higher spending level in retirement and/or support a greater legacy value for remaining assets.”

In recent years, the effective use of home equity to supplement a retirement income strategy has been demonstrated in various research articles from members of the financial planning community.

At the crux of this research has been the concept of obtaining a reverse mortgage early during retirement, thus letting the line of credit grow over time, which can then be used to draw from in instances where the retiree’s investment portfolio suffers negative returns. This concept allows retirees to strategically spend from their reverse mortgage credit line and, above all else, helps improve the sustainability of retirement income strategies.

While this strategy has been written about extensively on many different occasions, Pfau draws attention to research published by Barry and Stephen Sacks, which he credits as getting the ball rolling for other planners to begin considering this use for reverse mortgages in retirement income planning.

The Sacks brothers’ sought research sought to reverse the conventional wisdom of using home equity to supplement retirement income, by examining three strategies for incorporating home equity into a retirement income plan.

Such strategies included (1) using a HECM as a last resort only once the investment portfolio has been depleted (also referred to as the conventional wisdom approach); (2) opening a HECM line of credit at the start of retirement, which retirees can spend down first; (3) and finally, opening a HECM credit line at the beginning of retirement, drawing from it only during years that follow a negative return for the investment portfolio.

Through this research, the Sacks found that the remaining net worth of the household—the value of their remaining financial portfolio, plus any remaining home equity—after 30 years in retirement is twice as likely to be larger with an alternative strategy than with the conventional wisdom of using home equity as a last resort.

“For withdrawal rate goals of between 4.5% and 7% of the initial retirement date portfolio balance, the residual net worth after thirty years was 67% to 75% more likely to be higher with a coordinated strategy than with a strategy using the reverse mortgage as a last resort,” Pfau said. “In other words, spending home equity did not ruin the possibility for leaving an inheritance.”

Instead, the opposite was true, Pfau noted, because strategies (2) and (3) “provide a cushion against the dreaded sequence of returns risk that is such a fundamental challenge to building a sustainable retirement plan.”

When retirees use home equity last, they are spending down their volatile investment portfolio earlier in retirement and are more exposed to locking-in portfolio losses, which Pfau notes, more easily leads them on the path to depletion.

“Sacks and Sacks make clear that their point is not that all retirees should take a reverse mortgage, but that retirees who wish to remain in their homes for as long as possible should view it as more than a last resort,” Pfau writes. “If a retiree decides to spend at a higher level, which could lead to portfolio depletion and then possible require them to also generate cash flows from their home equity, there is indeed a better way.”

Read the Forbes article.

Written by Jason Oliva

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  • Jason,

    Job well done in your writing. This is what we need in our industry, as much positive press as we can get.

    It is very true, the HECM is a great retirement planning tool to be used at an early age. Even if one has investments that are tied to market indexes or if they are stocks. The line of credit grows and grows but is there when needed. It serves as a great hedge when one’s investment portfolio may be down due to market conditions.

    Just think, If you are a senior, you have investments like stocks, bonds or anything tied to market conditions and the market takes a nose dive, what do you do in an emergency if one needs more cash than what is available in savings?

    Our senior could cash in an investment like, one of their stock or bond portfolios and take a major market condition hit as well as take a penalty hit at the same time! Our senior could be much better off, drawing from the reverse mortgage line of credit.

    This way, no penalty, the senior has the time to wait until the market comes back and even improves. Then pay down the amount on line of credit the amount that was taken, if they so choose. Pretty darn good hedging tool, wouldn’t you agree?

    The article points out what an opportunity the reverse mortgage is for the financial community but more so for the senior!

    John A. Smaldone

    • John,

      But is this strategy not also filled with risk?

      What happens if by simple review, the senior could have discovered that he/she holds shares in stocks that are never expected to recover and by holding them will just continue to lose.

      While the strategy may work with a S&P 500 indexed fund, it could have been disastrous with a NASDAQ indexed fund at least since 2000.

      In probability theory we called these examples as created in a bubble. While the Monte Carlo Simulator does help with risk analysis, it is the assumptions that prove to be unreliable over time.

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