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Leveraging Home Equity to Address Volatility, Longevity, and Sequence Risk
By Longbridge Financial
Today’s retirees are increasingly facing financial challenges, most notably due to rising inflation and increasing debt burdens. According to recent data, the total debt for Americans over age 70 climbed to $1.1 trillion in 2019, a 543% increase from 1999, marking the largest percentage increase for any age cohort.1 With this figure in mind, perhaps it’s not surprising that nearly half of all Americans expect to retire in debt.2
Mortgage debt is a significant contributor to the situation. Today, despite nearly 80% of Americans aged 65 and older owning homes,3 nearly 10 million of them still carry mortgage debt.4 And the sobering reality is that an increasing number of older homeowners allocate over 30% of their income to housing expenses.5
With these major challenges impacting today’s retirees, there is an imminent need to create strategic sources of funds in retirement.
In retirement planning, longevity risk presents both opportunities and challenges. For starters, every additional year of retirement is another year your clients need to budget for. And extended retirements also come with amplified impacts of risks such as outliving investments, market volatility, fluctuating interest rates, and changes in tax rules and public policy. The sequence of returns risk is also prominent, as market downturns can affect retirees significantly, especially should they need to sell from a declining portfolio, missing out on the subsequent market recovery. Rising inflation rates are another risk, as they’ll need to keep up with the cost of living while being prepared for unanticipated expenses or personal spending shocks. A robust retirement plan should include a framework to address these various risk categories—and reverse mortgages offer unique solutions.
While reverse mortgages have long faced the misconception of being considered a last resort option, only to be used after depleting investment assets, historical data suggests using a reverse mortgage strategically as part of a retirement plan can significantly improve financial outcomes. Obtaining a reverse mortgage in early retirement years and using the funds strategically throughout retirement can provide an effective approach to leverage home equity and establish a more secure retirement.
With this in mind, let’s look at four general approaches to managing market volatility and longevity within sequence of returns risk in retirement.
- Spend Conservatively: Leveraging monthly payouts from a reverse mortgage, clients can decrease the distribution rate from investments and subsequently leave them to grow over time. Furthermore, refinancing an existing mortgage to a reverse mortgage can reduce, if not eliminate, these large payments in early retirement. Since reverse mortgage payments are optional (so long as the borrower keeps current with taxes, insurance, and home maintenance), clients can potentially free up even more additional cash flow, which could bridge the gap in delaying Social Security benefits. Once Social Security funds are eventually claimed, they may help offset withdrawals from investment portfolios.
- Spending Flexibility: Flexible or variable spending strategies are a less savvy approach, as they require changes in spending habits as opposed to strategically using various sources of funds. However, this approach is extremely straightforward: in the event of a market downturn, clients simply scale back their spending habits and prioritize opportunities to save money to weather the storm.
- Reduce Volatility: There are a number of strategies clients can take advantage of to address the risk of volatility in retirement. These include diversifying investment portfolios, adjusting asset allocation, and maintaining an emergency fund to provide a safety net in the event of market downturns. Since retirement can span several decades, it’s also a smart idea to periodically rebalance portfolios to maintain optimal asset allocation.
- Buffer Asset Management: The fourth general approach is to leverage funds from a reverse mortgage to avoid selling from portfolios during market downturns. A smart way to manage sequence of returns risk is by temporarily sourcing spending from a reverse mortgage; clients’ portfolios then have an increased opportunity to recover from fluctuating market conditions. Better yet, reverse mortgage proceeds are income-tax free,6 which could help clients defer or eliminate capital gains taxes when selling appreciated assets in taxable accounts—and allow them to leave assets in tax-deferred accounts like 401(k)s or IRAs to grow.
Despite the many challenges impacting today’s retirement landscape, seniors can—and should—get more out of their retirement. The reality is housing and healthcare spending consume resources and have the potential to drain financial assets when these funds could be used to enhance a client’s quality of life or create a better future for the next generation. In addition to establishing financial stability and easing tax burdens,6 reverse mortgages can allow seniors to tap into their housing wealth today and have more money later to pass on to the next generation.
When strategically used for extending retirement portfolio lifespans and increasing legacy values, a reverse mortgage can:
- Provide an alternative funding source
- Allow a portfolio to stay invested longer for potentially higher returns
- Create a higher likelihood of portfolio survival
- Increase net legacy and lower taxable income6
A reverse mortgage can also help increase the sustainable withdrawal rate for a retirement portfolio and be used to help secure a portfolio in down markets—lessening the chance of liquidating assets at the worst possible time. Funds can be repaid as markets recover with no prepayment penalties. Even the simplest and most straightforward strategies can make a profound impact on improving clients’ cash flow and providing more stability in retirement.
Third-party content included in this article belongs to the third party and doesn’t necessarily reflect Longbridge’s policy/position. This article doesn’t constitute financial/tax/compliance/legal advice. Not for consumers.
1 Debt among older Americans increases dramatically in past two decades (cnbc.com)
2 https://www.magnifymoney.com/news/dream-retirement-survey/#DespiteLoftyKeyfindings
3 Get the Facts on Home Equity and Seniors (ncoa.org)
4 Where Older Americans Make Up Largest Share of Homeowners | LendingTree
6 Clients should consult a financial advisor/appropriate government agencies for any effect on taxes/government benefits.
image credit: Adobe Stock Images
