My article last week discussed the longevity annuity as a tool for protecting retirees who are heavily dependent on a stock of financial assets against the risk of running out of money.
The retiree in my example was 65 and had assets of $600,000, from which he could draw $3,000 a month until reaching age 100, at which point his assets would be fully depleted — not a happy prospect for someone who might live that long.
But this retiree could use $200,000 of his nest egg to purchase a longevity annuity that began payments of $3,000 after 10 years, which would eliminate the risk of impoverishment.
Adding a HECM reverse mortgage credit line
If the retiree described above had equity in his home, he could draw on a reverse mortgage credit line to strengthen his retirement further. A $200,000 line, for example, if added to his other financial assets, would extend the period within which he could draw $3,000 a month without running out of money until he was 110. This would eliminate the need for a longevity annuity, but would very likely leave considerable money in his estate.
An alternative would be to increase his monthly draw from $3,000 to $4,000 and insure the continuity of the payment by investing $150,000 in a longevity annuity. The HECM credit line could be viewed as the payment source for the annuity.
In sum, the retiree dependent on a stock of financial assets could use a HECM credit line either to increase security as a replacement for longevity insurance, or to increase spendable income with a longevity annuity used to provide security.
Uses of a HECM by retirees dependent on pensions Retirees with equity in their home, who depend on pensions rather than a nest egg of financial assets, can supplement their pension income using a HECM reverse mortgage in either of two ways. One way is to exercise the “tenure” option under the HECM program, and receive a fixed annuity payment for as long as she remains in the house. The second way is to exercise the credit-line option, using some or all of it to purchase an immediate annuity from a life insurance company. (Note: An immediate annuity begins payments in month one, where the longevity annuities discussed earlier delay the payments until a future date.)
I shopped both options in early January 2016 for a female of 70 with a house worth $400,000 and no existing mortgage. Under the tenure option, she could draw $1,256 a month. This is the largest amount available from any of the 11 reverse mortgage lenders who report their prices to my website.
Alternatively, she could select the largest credit line available from those lenders, which was $224,280, and use it to purchase an immediate life annuity from an insurance company. The largest such annuity available from 9 AA-rated companies that report to www.immediateannuity.com. was $1,349. Note that these purchases must be done in two stages because part of the HECM credit line is not available for 12 months.
Advantages and disadvantages of the two approaches
While the HECM tenure annuity pays less than the life annuity, the borrower retains ownership of the reserve account underlying the annuity. This allows her to change her mind after a few years and switch to a credit line for the reserve amount still available. And if she dies early, the remaining equity in her home goes to her estate. On a life company annuity, in contrast, early death terminates all payments unless the policy has a guaranteed payout, which would reduce the annuity amount.
In addition, the HECM tenure annuity is guaranteed by the federal government. The life company annuity is only as good as the promise of the insurance company, loosely backed by state guarantee programs. Defaults on annuities, however, are extremely rare.
On the other side of the ledger, if the borrower gets sick and has to go to a nursing home, the HECM annuity will terminate after a year of non-occupancy. That’s why it is called a “tenure payment” rather than a “life annuity.” The lender takes the house after the year and sells it, with any equity remaining going to the borrower’s estate.
With a life insurance company annuity, in contrast, the senior could be in a nursing home indefinitely without shutting off the annuity.
Regulation of life annuity purchases with HECM funds At an early stage in the evolution of the HECM market, some seniors were induced to take out mortgages for the express purpose of purchasing life annuities. The loan officers involved earned two commissions, and the needs of the senior were often disregarded.
As a result, a law was passed that in effect prevents a lender from disbursing funds at the closing that will be used to purchase an annuity.
But the law is not an impediment to seniors whose retirement plan includes the purchase of a life annuity from an insurance company. They need only to take a HECM credit line at closing, then draw on the line later to pay for the annuity. This keeps the HECM transaction and the annuity transaction separate, as they should be, and allows the senior to shop for them separately.
The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.