Reverse mortgages and retirement incomes

drifinancial

A reverse mortgage closes the gap between your income and expenses and helps provide a tax efficient, monthly income for life.

Executive Summary:

For many pre-retirees, their pending decumulation stage causes stress and anxiety. Pre-retirees have saved and invested for decades, and in retirement, they stop earning and start using their savings.

Poor investment returns, insufficient savings or longevity cause many retirees to worry about outliving their savings.

We help clients arrange their multiple buckets of assets in a manner that produces a tax efficient monthly retirement income for life. This involves using tools such as life annuities, dividend paying stocks, maximizing CPP and OAS, life insurance and reverse mortgages. Or sometimes, it comes down to arranging the most tax efficient sequence for withdrawing money from registered and non registered assets.

A reverse mortgage allows retirees to age in place, eliminates the costs of moving, provides a supplementary income/lump sum for personal use or to provide an early inheritance. However, a reverse mortgage reduces the value of one’s estate and should only be considered if the objective is to maximize retirement income.

This article explains the features of a reverse mortgage and how it can be used to help create a tax efficient monthly income for life. If you are within five-years of retirement and not sure how your retirement income sources fit together or how much they will generate, give my office a call and I will personally help you organize a retirement income for life strategy.

Living off savings is stressful

For some retirees, their retirement lifestyle expenses exceed their income, and the shortfall causes them to defer/avoid vacations, home improvements, car repairs and possibly even healthcare. Often the shortfall is caused by poor investment returns, insufficient savings, overspending during their working years or simply a misunderstanding of the effects of inflation. The use of a reverse mortgage may help to create a tax efficient monthly income for life.

In my last two articles I reviewed some retirement income options. In my previous articles, I suggested selling the family house and/or deferring CPP and/or OAS benefits (and accelerating RRSP withdrawals). This article reviews the benefits of a reverse mortgage and how it can help provide a tax efficient income for life and close the income gap.

The purpose of a reverse mortgage

A reverse mortgage is a lump sum or periodic payments received from a lender, which are registered against the value of a principal residence. This part is very similar to a standard mortgage, but the similarities end here!

A reverse mortgage does not require the borrower to make payments and all interest expense is accrued. When the borrower dies or sells the house, the principal and the accrued interest is due and usually paid from the proceeds of the home sale.

Features of a reverse mortgage

There are many features (both good and bad) to a reverse mortgage and I will continue to stress that their purpose may not suit all retirees.

  • The mortgage is secured against a principal residence,
  • They are available to Canadian residents over the age of 55,
  • The maximum loan is 55% of value of the house,
  • The lump sum or the periodic payments are tax free,
  • The homeowner must continue to pay the property taxes, insurance, and all home maintenance
  • The mortgage is due when the homeowner dies, sells, or moves into a retirement home (or long-term care facility),
  • Some lenders guarantee that the mortgage balance will never exceed the value of the home when sold,
  • The interest rate is usually higher than a conventional mortgage and terms range for 1-5-years (current interest rate for a five-year fixed term is 5.25% – 5.75%), and
  • Repayments of the loan are permitted but with penalties applied.

Benefits of a reverse mortgage

If you are in the right place in your life for a reverse mortgage then the benefits are significant:

  1. Ageing in place: It allows the homeowner(s) to stay and age in place versus moving to a smaller property or a retirement community.
  2. Eliminates the costs of moving: Downsizing is expensive and very stressful, staying in your existing home avoids the costs and hassles of moving.
  3. Provides supplementary income: The lump sum or the periodic payments received are tax free and can supplement cash-flow requirements.
  4. Many uses for a lump sum payment: A lump sum may be used for home renovations, gifts for kids, paying off debts, paying for healthcare expenses etc.

The story of Mr. and Mrs. Lifestyle

To demonstrate how a reverse mortgage works, here is an example from about 20 years ago. Mr. and Mrs. Lifestyle were a 75-year old couple, who’d been retired for five-years, and owned a home in Toronto worth $1,000,000, at the time. When we met, they were complaining that their investment assets weren’t providing the desired monthly income. They had reduced their monthly expenses to match their income but were looking for ways to create a small amount of supplementary money to fund the retirement lifestyle that they’d envisioned for their senior years.

Prior to investigating the possibility of a reverse mortgage, they’d considered the following:

  • They’d considered downsizing their home but have decided against the idea because they love their home, the area and were surrounded by their friends who lived nearby.
  • They’d considered renting the basement but at their age, they didn’t want the hassles of dealing with tenants.
  • They’d applied for a home equity line of credit (HELCO) but the bank rejected their application because of their income. But, they weren’t overly disappointed, HELCOs are callable on demand and don’t satisfy their need for a monthly income for life.
  • Finally, they’d considered a reverse mortgage to supplement their income and eliminate the monthly cash shortfall.

At the time of writing, reverse mortgages are offered by two banks and several private lenders. Each lender has unique features, but the basic features were covered earlier in this article.

Mr. and Mrs. Lifestyle were approved for a maximum loan of $3,000 per month (the lump sum option was not suited for their requirements). This monthly loan completely eliminated their cash-flow deficiency, enabling them to enjoy the retirement lifestyle they wanted, so they took out the reverse mortgage.

After five-years, they had borrowed $180,000 and accrued $27,249 in interest (total loan after five-years was $207,249). After 10-years, they had borrowed $360,000 and accrued $119,089 of interest (total loan after 10-years was $479,089).

They both died at 90. The reverse mortgage had grown to $835,647 ($540,000 of principal and $295,647 in accrued interest), however, the home also appreciated by 2% per year and was worth $1,345,868.

On second death, the estate was worth $510,221 ($1,345,868 minus $835,647). Obviously, if Mr. and Mrs. Lifestyles avoided the reverse mortgage and somehow made “ends meet”, their estate would have been worth $1,345,868 (assuming their home was the only asset left at second death), but why should Mr. and Mrs. Lifestyle have lived in frugality for the sake of leaving a large estate upon their deaths?

Is a reverse mortgage worth the trouble?

I don’t mean to sit on the fence but the answer depends on your objectives. If the objective is to maximize retirement income without worrying about the value of the estate, then a reverse mortgage helps create income for life.

A tip to reduce the mortgage balance is to defer a reverse mortgage until later in life, perhaps until mid 70s. Any cashflow shortfall can hopefully be recovered from accelerating the decumulation of other assets. For example: cash accounts first, then registered accounts second, and finally TFSAs.

However, if the objective is to maximize the value of the estate, then a reverse mortgage fails to achieve the objective and shouldn’t be considered.

The options are endless…. or are they?

If you’re in your 50s or nearing retirement, you have many more options to bolster your future retirement income, such as:

You have fewer options if you’re already enjoying retirement, however, it is still important to have a plan! I call this an Investment Policy Statement (IPS), which is a four-step plan to manage your wealth:

  1. Establishing your goals,
  2. Determining the amount of time to reach these goals,
  3. Deciding on your risk tolerance, and
  4. Selecting the investments that will help you achieve your goals.

Listen to my podcast about IPSs and how they are central to a successful investing strategy, then give me a call and I will personally assist you with your retirement planning.

Final Thoughts:

Personally, I have financially supported my children through private schools, undergrad and postgrad degrees and believe they have all the necessary tools to succeed on their own. I plan to enjoy my assets during the remaining years of my life and leave the kids whatever is left, if anything.

For me, a reverse mortgage is a valuable tool in my retirement income toolbox, and I will not be afraid to use it, if necessary, to maintain my optimal lifestyle.

If you are within five-years of retirement or in early retirement and not sure where your retirement income will come from, call my office and I will personally help you create a tax efficient monthly income for life. In fact, if you have any goal in mind — big or small — that requires some financial planning, but you’re struggling with where to start, reach out to our team. We have the expertise and life experiences to help guide you to achieving your goals.

Contact us today to learn more about the options available to you. CLICK HERE.

Learn more:

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We offer you a range of services from creating bespoke financial plans and providing investment advice to helping you take advantage of our investment models. If you would like more information on the Wealth Navigator Process or our team, call me any time at 416.355.6370 or email me at richard.dri@scotiawealth.com.
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The Dri Financial Group motivates entrepreneurs and their families to enhance their financial life. Our team of experienced entrepreneurs, personalized financial planning tools and proprietary investment strategies are the cornerstone of our program’ s success

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