If you are in your retirement risk zone (within 10 years of retirement) or if you have just retired, here is a question for you: Are you planning to reverse-mortgage your house?
Reverse mortgage as a means of generating retirement income caught on in the US, especially among retirees who were asset-rich, cash-poor. The question is: Will reverse mortgage work for you? In this article, we discuss certain features of the reverse-mortgage-linked annuity and explain why it fits with our preferred retirement income portfolio.
Reverse mortgage is primarily for individuals who are asset-rich, cash-poor. By cash-poor, we essentially mean individuals who do not have enough portfolio investments to support their desired lifestyle post-retirement. The question is: If you are asset-rich cash-poor, should you consider reverse mortgage?
The classical reverse mortgage is unattractive, as it has a fixed tenure not exceeding 20 years. This means that the bank will not pay the periodic cash flow even if you or your spouse survive beyond 20 years after your retirement. You are, therefore, exposed to high longevity risk- the risk that you will outlive the cash that the bank will pay you based on your property value.
But you can consider reverse mortgage loan enabled annuity or RMLeA. This is a new version of reverse mortgage that moderates your longevity risk. How? The bank will value your property and decide the quantum of loan. Typically, banks will offer 60 per cent of your property value if you are between 60 and 70 years old and about 75 per cent, if you are 80 or above. This loan amount will then be used by the bank to buy you a life-time annuity, which will pay you a fixed sum of money every month till your lifetime. Or you can choose an annuity that will pay either you or your spouse, whoever survives longer. But how does RMLeA serve your requirement?
Annuity for living
Your expenses post-retirement can be divided into three buckets- leisure, living expenses and non-ordinary health-care expenses such as major surgery. Now, if you are asset-rich cash-poor, your immediate priority is to provide for your living expenses and emergency funds to take care of medical emergencies. The RMLeA fits nicely with your financial situation. How?
You can fund your post-retirement living expenses with annuity. Because you will receive stable cash flows every month, you need not bother about interest rate or equity market fluctuations during your retired years to sustain your basic living. Annuity fits with our Wealth Mapping process for retirement income portfolio, where we map investment products to a retiree’s consumption buckets. Of course, you still need to set aside money to create your emergency fund. You also need a small corpus for annual repairs and maintenance for your house.
The advantage with RMLeA is that it allows you to cash out your equity in the house and purchase a stable cash flow product to support your lifestyle post-retirement. Importantly, you can purchase an annuity with return of purchase price. Of course, the monthly payments on such an annuity will be lower but it makes it easier for your children to repay the bank loan and repossess the house, after your lifetime or your spouse’s. Taking RMLeA may not, therefore, seriously affect your desire to leave a legacy for your children.
Conclusion
You have to carefully choose your RMLeA; review the annuity contract to check whether the periodic payments are attractive. Also, keep in mind that annuity is taxable. You should have a term insurance on yourself and your spouse, if possible, with your children as the beneficiaries. After your lifetime or that of your spouse, the proceeds from the insurance policy may be used by your children to repay the interest on the bank loan.
(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investor-learning solutions. Feedback may be sent to >knowledge@thehindu.co.in )