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Retirement is meant to be a time to kick back, relax, and enjoy the fruits of your years of labor. But for many Americans, their savings just doesn’t add up to support them in retirement. So we wanted to know: How can you incorporate one of your biggest investments, your home, into your retirement plan? We asked Jamie Hopkins, the Associate Director of American College’s New York Life Center for Retirement Income, to weigh in.
When a person doesn’t have enough money saved for retirement, that person is going to rely heavily on Social Security. A reverse mortgage can provide income on the first part of their retirement so that person can defer Social Security as long as possible, hopefully until age 70. A reverse mortgage can also help reduce sequence of returns risk, especially in the early years of retirement. This can help provide you the income to live on early in retirement and avoid selling your investments when the market suffers a bad year.
Reverse Mortgages got a bad rap because they were used at the end of retirement as a last resort and that’s not the best use. They’re much better used at the front end of retirement or in a down market so you don’t have to spend your investments. Reverse mortgage rules have also changed substantially over the past year. The old rules meant they were more expensive and could be sold to people with a lot less income who didn’t have the finances to be taking one on. Now you have to prove you’re stable enough in order to get one. It’s a relatively new concept of strategically using them at the beginning of retirement as opposed to a last resort at the end.
When we’re talking about home equity and your retirement plan, you need to go through a lot of different questions. Are you planning on living there your whole retirement or 5-10 years and then downsizing? Will you move to a retirement community? All of that is going to have an impact. If you plan on staying in your home, you might undergo renovations to make the house senior-friendly. Things like handrails, ramps, whatever it might be to make it friendlier for someone in their 70’s and 80’s. You should also be thinking “How can I turn this home into income at some point?” That might be a traditional line of credit, reverse mortgage, or home sharing—which is the Golden Girls example of living with other retirees to reduce expenses and gain companionship. You can consider a sale leaseback, which gives you an influx of cash and allows you to keep living in your home—it’s often done with family members. You can also think about downsizing. You raised five kids in your home, but now that they’re gone do you need a six bed house for two to three people? Probably not, so you might be able to cut down on taxes, heating and cooling, and other expenses by moving.
Downsizing should absolutely be considered as part of your retirement plan. For a lot of individuals you’ll have limited ability to increase income in retirement through investments, so you have to focus on reducing your expenses. One way to do that can be downsizing your home in the same state or moving to a different state with lower taxes and a lower cost of living. That will also free up some home equity, you can then spend or invest.
The first part is to make sure your children want the home. What we see with estate planning is the children don’t want the home and they end up selling it soon after inheriting it. So if all you were leaving is an encumbered lump sum amount to the kids, maybe there was a better way to use the home during your retirement. If your children do want the home you could explore a sale lease back and leave it to them while you’re still alive. For high net worth individuals, you can consider a QPRT, which can help pay for estate taxes, but that’s usually not needed for most people. For any transfer of a home—selling, gifting, leaving it to estate, putting it in a trust—there are tax implications that are state driven, so you should always consult an attorney familiar with your state laws
Prepaying a mortgage, finance-wise, has the same effect as saving in an investment with a return that is the same as your interest rate. So if you have a mortgage with a 4 percent interest rate, prepaying the mortgage is the functional equivalent of saving or investing at the same return, 4 percent. Prepaying a mortgage needs to be compared to like kind investments or safe investments like bonds or CDs.
When you’re deciding whether or not to prepay, you have to consider where else you’d be putting those assets. If you would otherwise invest in bonds or CDs, prepaying might be a better option with the way current interest rates are, but if you’d otherwise invest in the stock market, prepaying might not be right for your portfolio. Remember, you want to keep the correct allocation for yourself. So don’t only invest in bonds and then also start prepaying your mortgage. Instead, make sure you diversify your risks and invest in the market, bonds, and consider prepaying the mortgage to supplement those options.
The takeaway: I think the important thing is not to forget home equity as a potential income source, especially reverse mortgages. For the average American, it’s the second largest source of wealth outside Social Security, so it’s important to make sure that it’s effectively and strategically used—and all the research shows we need to be using it at the beginning of retirement.
Jamie Hopkins is the Associate Director of American College’s New York Life Center for Retirement Income and an Associate Professor of Taxation in the American College’s Retirement Income Certified Professional (RICP) program, the leading retirement income education program in the country. He’s a frequent contributor to Forbes, where he covers retirement issues such as long-term care, taxation of insurance benefits, and estate planning.