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Should I use reverse mortgage funds to buy an immediate annuity

Should I use reverse mortgage funds to buy an immediate annuity

One of the goals of any retirement plan is to maximize all of a senior’s retirement resources. It takes a lot of calculations and analyzing different scenarios to determine what products to buy and how much of a person’s assets to allocate to those various options.

A strategy that has been employed in the past is to obtain a reverse mortgage, take a portion of those proceeds in a single lump sum payment, and allocate that payment to a single premium immediate annuity.

A quick comparison

If you are 65 and own a home valued at $400,000, you could obtain a reverse mortgage with a principal lending limit of about $206,000. If you opted for the tenure payment option, meaning you will receive the same monthly income for as long as you continue meeting the requirements of the contract, you could receive about $1,060 a month.

Now consider a scenario in which you take $100,000 of you reverse mortgage limit upfront and use it to buy a single premium immediate annuity. This type of annuity will pay income immediately upon the start of the contract, for a certain period or for life if you choose.

If you choose the lifetime option, the $100,000 annuity will pay you about $500 a month.

The remaining principal on the reverse mortgage after the $100,000 withdrawal will still offer $546 a month. So the combined total, $1046, would more or less be equal to what the reverse mortgage itself would offer. So why do it?

The annuity option could prove advantageous if in a few years you were forced to move out for health reasons and/or transfer to assisted living or long-term care. Under the terms of the reverse mortgage, payments stop as soon as you move out of your home, and the loan becomes due, while the annuity income will continue for the rest of your life.

On the other hand, if you die within a few years of buying the annuity, then it would have probably been better just to stick with the reverse mortgage. That’s because when it’s time to repay a reverse mortgage, you only owe the amount you borrowed plus interest.

The immediate annuity, on the other hand, is an upfront cost. If you die before getting full benefit from the annuity, your heirs essentially lose out. You can buy an annuity that guarantees income for a minimum number of years, but it will offer a lesser payout than an annuity that just pays out for a lifetime, regardless of length.

How to evaluate your options

In general, the SPIA strategy could provide more income the higher the principal limit available to the homeowners, the higher the rates being paid on SPIAs, and the older the retiree. Also, single retirees can net more from the SPIA strategy than those who are married because SPIAs pay out less when two lives are covered.

Here is one example: a 75-year-old with a $400,000 home could obtain a reverse mortgage principal limit of $235,000, which would produce a tenure payment of almost $1,400 a month.

The same retiree could take $125,000 upfront and use it to buy an immediate annuity. Under that scenario, the reverse mortgage would still pay $652 a month, while the immediate annuity would pay $900 a month for life. So, the retiree could receive an extra $150 under this arrangement.

Now imagine an 80-year-old retiree, who could obtain a principal limit of $252,000 on the same $400,000 home. If the retiree took nothing upfront and set up a tenure payment option, he or she could collect $1,681 a month for as long as they lived in the home.

Or the retiree could take out $125,000 upfront from the reverse mortgage to buy an SPIA. An SPIA of that amount to an 80-year-old will pay about $1,100 a month for live. The remaining principal available on the reverse mortgage would offer a monthly tenure payment of $848. That’s a total of $1,948 a month in income, almost $300 a month better than just relying on the reverse mortgage.

The bottom line of whether this strategy is beneficial is to compare the income you can generate from both. If the difference is considerably higher, then it may be to your benefit to take reverse mortgage funds to buy an SPIA. Otherwise, you are probably better off not taking a large upfront payment and just opting for the tenure payment option.

Federal law prohibits a lender or reverse mortgage broker from requiring the borrower purchase another financial or insurance products as a condition of the reverse mortgage.

If another product is offered to you, make sure you understand how it works, what it’s benefits are, what it costs, and ultimately whether you need it.