Six Ways to Use a Reverse Mortgage to Protect Retirement Income

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Wade Pfau, Ph.D., CFA

Reverse mortgages have long been shunned by many financial professionals, often thought of as a lifeline for desperate and broke seniors.  This thinking wasn’t misplaced.  Reverse mortgages were often often only used for these type of scenarios.  But as retirement planners are facing the harsh reality of slower than anticipated growth in investments and a stagnant economy, they are fast beginning to understand how under-utilized home equity and reverse mortgages have been – and how they can be the missing puzzle piece for so many of their clients.

In some latest research, Wade Pfau, a professor of retirement income at the American College of Financial Services, examined six ways to use a reverse mortgage as part of retirement-income plan.

Here are those six strategies:

  • Use home equity first: With this strategy, you’d open a line of credit at the start of retirement, and use this line to pay for all your retirement expenses until the line of credit was fully used up. This allows more time for the investment portfolio to grow before being used for withdrawals after the line of credit is depleted, wrote Pfau.
  • Use home equity last: Here, you’d open a line a credit at the start of retirement and only use it after your investment portfolio was depleted.
  • The Sacks and Sacks Coordination Strategy: With this strategy, you’d open a line of credit at the start of retirement, and use the line of credit, when available, following any years in which the investment portfolio experienced a negative market return, wrote Pfau. No efforts are made to repay the loan balance until the loan becomes due at the end of retirement, he wrote.
  • The Texas Tech Coordination Strategy: This method is a bit more complicated. With this one, you’d open a line of credit at the start of retirement and then each year you’d analyze whether you can keep withdrawing money from your investment portfolio at the desired rate over a 41-year time horizon. If the remaining portfolio balance is less than 80% of the required wealth you’d tap the line of credit, when possible. And if the portfolio balances is greater than 80%, you’d pay down provided your portfolio did not fall below the 80% threshold the balance on the reverse mortgage balance. This, Pfau wrote, would provide more growth potential for the line of credit.
  • Use tenure payment: Here you’d open a line of credit at the start of retirement and a receive a fixed monthly payment for as long as the borrower is alive and lives in the house. And spending needs over and above that reverse mortgage payment would be covered by the investment portfolio when possible, Pfau wrote.
  • • Ignore home equity: This strategy makes no use of home equity, and Pfau only examines it to show the probability of a retirement-income plan succeeding when home equity isn’t used.

So what did Pfau find?

Generally, strategies which spend the home equity more quickly increase the overall risk for the retirement plan, he wrote. More upside potential is generated by delaying the need to take distributions from investments, but more downside risk is created because the home equity is used quickly without necessarily being compensated by sufficiently high market returns.

Meanwhile, he wrote, opening the line of credit and that start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement-income plan.

Reverse mortgages are available to seniors 62 and over as long as the home the loan is being used against is the primary residence and there is some equity available.

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