Mortgage Professor: Why Reverse Mortgage-funded Annuities Should Lead a Federal Tax Code Change

The use of a reverse mortgage’s credit line to purchase a deferred annuity in order to use a combination of monthly draws from the credit line and annuity payments after the deferment period could make a major impact on the longevity of a borrower’s retirement finances, but such a tactic is heavily looked down upon by insurers. A change in the Federal tax code, however, to eliminate taxes on annuity payments that had been wholly funded with reverse mortgages could serve as a potential answer to this issue, according to Jack Guttentag, aka “the Mortgage Professor” in a new column at Forbes.

“[I]nsurers today view annuities funded by reverse mortgages as ‘unsuitable,’ and will not accept them,” Guttentag writes. “As a result, retirees today can use the credit line/annuity combo only through subterfuge. A determined retiree can place the funds drawn on the credit line into a bank deposit or investment account, then cite this account as the funding source of the annuity. Such cases are very uncommon.”

One of the major reasons insurers view annuities funded by reverse mortgages as an “unsuitable” arrangement is because it creates a “switch” from untaxed payments to taxed payments, since an annuity purchased with a reverse mortgage’s loan proceeds would be treated as a “non-qualified” purchase that then opens the annuity payments in excess of the paid premium to tax exposure, he says.

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“Concerns about suitability would largely disappear if the Federal tax code was modified to eliminate taxes on annuity payments that had been wholly funded with reverse mortgages,” Guttentag says. “In effect, this change in the tax code would provide a Federal sanction to HECM/annuity combinations. There is also precedent for such action: 4 of the 8 states that currently tax annuity payments exempt annuities purchased with funds from IRAs, 401Ks and 403bs.”

While there are an abundance of crises that the government has to deal with today, this is one potential path forward to face the looming retirement crisis and the amount of house rich/cash poor seniors that are about to transition into life on a fixed income, Guttentag says.

“[M]illions of Americans are fast approaching retirement with their wealth largely or entirely in their home equity.,” Guttentag writes. “Treating HECM-funded annuity payments as tax-exempt could increase the spendable funds available to these hard-pressed retirees at a period in their lives when those dollars count most. There would be no loss in Federal tax revenues because the number of credit line/annuity combinations now being written is negligible. And because the tax [ex]emption would result in more annuities being written, there would be an increase in revenues in the 8 states that now tax annuity premiums.”

Read the column at Forbes.

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