By Richard A. Dulisse, CLU, ChFC, MSFS, LUTCF

Today’s seniors, facing the increased living costs associated with longer life expectancy, are seeking nontraditional sources of income to maintain their retirement lifestyles. Reverse mortgages used in conjunction with an annuity can help seniors satisfy their retirement income needs.

Reverse mortgages
A reverse mortgage is a loan against an individual’s home that allows a client to live in his or her home and receive substantial amounts of money for current needs with no repayment for as long as the individual continues to live in the home. They are typically available only when the owners are age 62 or older, and when the home is the principal residence. Also, the home must either have no or little indebtedness, which can be paid off with part of the reverse mortgage loan.

An annuity and reverse mortgage combination can offer a higher monthly income than is available from a stand-alone reverse mortgage plan.

Reverse mortgage programs are primarily offered by the Department of Housing and Urban Development (HUD) and the Federal National Mortgage Association (Fannie Mae). The amount of loan payments made to the client depends on the:

• client’s age
  
• amount of equity in the home
  
• applicable interest rate and fees

These programs will also have maximum loan amount limits that change annually. Payment options will vary, but generally fall into one of the following categories:

1. Line of credit: This allows the borrower to make lump-sum withdrawals up to a certain level or in an annually increasing maximum amount, at the time and in the amount of the borrower's choosing.
   
2. Tenure: This gives the borrower a monthly payment from the lender as long as the borrower lives and continues to occupy the home as a principal residence.
   
3. Term: This gives the borrower monthly payments for a fixed period, which the borrower selects.

Also, the line of credit option can be combined with either the term or tenure plans.

Repaying a reverse mortgage
The amount of the loan grows based on the amount borrowed plus accumulated interest. Typically, repayment of the loan is required when the last surviving borrower either dies, permanently moves or sells the home. Most reverse mortgages are nonrecourse, meaning the maximum amount that has to be repaid is the value of the home. Therefore, even if the property’s value erodes, the maximum amount due to the lender will always be the lesser of the loan balance or the market value of the home.

Seniors tend to raise three concerns about reverse mortgage programs:

• outliving income from lump-sums taken from the line of credit option
  
• lapse of monthly payment because the monthly income from a reverse mortgage stops when the borrower moves or sells his home
  
• lower-than-desired payments

The reverse mortgage/annuity combination
A strategy that combines an annuity with a reverse mortgage can increase seniors’ retirement income and alleviate their objections to standard reverse mortgages. For instance, a lump sum of equity from a reverse mortgage could simply be rolled into an immediate annuity providing income payments for life, regardless of whether the home is sold. In addition, an annuity and reverse mortgage combination can offer a higher monthly income than is available from a stand-alone reverse mortgage plan.

For example, suppose Mr. Smith is the 65-year-old owner of a home worth $150,000, and is interested in receiving extra retirement income. A basic HUD loan provides him with a reverse mortgage lump sum of $86,444, or $484 of monthly life income.

Alternatively, Mr. Smith could divide the $86,444 into two parts. Using the line of credit option, he could use a $50,000 lump sum and receive $564, or an additional $80 per month, with a nine-year term payout. Simultaneously, he invests the balance of $36,444 into a tax-deferred annuity. (The deferred annuity would have to earn a sufficient interest rate--5.7 percent--during the nine-year period to grow to a lump sum of $60,000, which could then be used to purchase an immediate annuity to pay him $564 monthly for life.) At the end of the nine years, Mr. Smith then stops receiving payments from the reverse mortgage and annuitizes the deferred annuity, which continues to provid him $564 of monthly income for life.

Tax considerations
Reverse mortgage payments are considered to be returns of principal, thus they are tax free and do not impact Social Security retirement benefits.

A tax-deferred annuity has no tax due on asset accumulation until withdrawals are taken. Withdrawals are considered to come first from interest, which is fully taxable.

However, each annuitized payment consists of interest and principal. The interest portion is taxable, but the return of principal portion is not. Annuity payouts may also impact the taxation of Social Security benefits that may in turn have a marginal effect on one’s total tax liability.

Richard A. Dulisse, CLU, ChFC, MSFS, LUTCF, is an LUTC author and editor. He can be reached at richardd@Amercoll.edu.

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