We thought we would post a summary of an article from our most recent newsletter about using reverse mortgages as a risk management tool for retirement planning:
Standby Reverse Mortgages for Retirement Planning
What does a successful retirement mean to you? Everyone has a different idea of what is important to them, but some of the common ingredients are reasonable health, the ability to travel and visit family and the security of not having to worry about their nest egg lasting the rest of their lives.
Not surprisingly, financial advisors spend an awful lot of time thinking about these sorts of things because a safe and comfortable retirement ranks very highly with the kinds of goals that their clients would like their money to enable. Just how to make that nest egg last a lifetime has always been an important topic for analysis and discussion.
Let’s assume a hypothetical situation that features a $1,000,000 portfolio with an annual withdrawal of 5% ($50,000). The portfolio is expected to grow at 6% - 7% and even with the withdrawal there is room for small annual growth. That growth is important because when planning for retirement income over several decades there is a need to increase the annual withdrawal by a small amount each year to account for inflation.
All seems well and good until a situation such as 2008 comes along. Stocks dropped in excess of 60% from the high in late ‘07 to the low in early 2009. Even assuming that bonds were not affected a portfolio 50/50 in stocks and bonds had a value decrease by close to 30%. This means that the 5% our hypothetical couple was taking from their accounts was suddenly closer to 7.5%. Or, put another way, the $1,000,000 reduced by their annual $50,000 withdrawal and reduced further by market volatility was suddenly worth only $650,000 at the bottom, a breathtaking drop in value.
This couple knows that their 7.5% withdrawal is too large of a percentage to be sustained over time. And they don’t feel at all happy about having to liquidate stocks to fund their retirement income needs when they are trading at such low levels. At this point they can either reduce their income draw to 5%, sell bonds in their portfolio in lieu of stocks to provide income or permanently damage their prospects of portfolio longevity by continuing on their current course, eating their seed corn to fund current living expenses.
With a little planning the brunt of this situation could have been deflected. We’ve long advocated the use of a cash reserve fund - a couple years of expenses in reserve to provide income in times like these. But in these times of low interest rates, the opportunity cost for that sort of fund can be significant. That money in today’s environment is earning nothing. But in the above situation such a fund would be of tremendous value, allowing the spending of that cash while waiting for the inevitable upward market movements that follow market downturns of that magnitude.
In a recent study several prominent planners created an analysis of using a new sort of reverse mortgage (the Home Equity Conversion Mortgage or HECM) as a complement to traditional portfolio drawdown strategies including a reserve fund. Based on their analysis, published in the Journal of Financial Planning, using reverse mortgages had the potential to provide more favorable outcomes.
Cash reserves and other tools, such as a reverse mortgage, can be valuable tools to help your retirement plan withstand market volatility.
Many thanks to Cal Abts, Reverse Mortgage Specialist at HomeStreet Bank for his invaluable assistance with this article.