Life Annuities and HECM Reverse Mortgages as Tools For
last week (How
Retirees Can Avoid Running Out of Money: The Role of
Longevity Annuities) discussed the longevity annuity as
a tool for protecting retirees heavily dependent on a stock
of financial assets against the risk of running out of
money. The retiree in my example was 65 and had assets of
$600,000 from which he could draw $3,000 a month until
reaching age 100, at which point his assets would be fully
depleted -- not a happy prospect for someone who might live
that long. But this retiree could use $200,000 of his nest
egg to purchase a longevity annuity that began payments of
$3,000 after 10 years, which would eliminate the risk of
Uses of a HECM by Retirees
Dependent on Financial Assets
If the retiree
described above had equity in his home, he could draw on a
reverse mortgage credit line to strengthen his retirement
further. A $200,000 line, for example, if added to his
other financial assets, would extend the period within which
he could draw $3,000 a month without running out of money
until he was 110. This would eliminate the need for a
longevity annuity, but would very likely leave considerable
money in his estate.
would be to increase his monthly draw from $3,000 to $4,000
and insure the continuity of the payment by investing
$150,000 in a longevity annuity. The HECM credit line could
be viewed as the payment source for the annuity.
In sum, the
retiree dependent on a stock of financial assets could use a
HECM credit line either to increase security as a
replacement for longevity insurance, or to increase
spendable income with a longevity annuity used to provide
Uses of a HECM by Retirees
Dependent on Pensions
equity in their home, who depend on pensions rather than a
nest egg of financial assets, can supplement their pension
income using a HECM reverse mortgage in either of two ways.
One way is to exercise the “tenure” option under the HECM
program, and receive a fixed annuity payment for as long as
she remains in the house. The second way is to exercise the
credit line option, using some or all of it to
purchase an immediate annuity from a life insurance company.
(Note: An immediate annuity begins payments in month one,
where the longevity annuities discussed earlier delay the
payments until a future date.)
I shopped both options in early January, 2016 for a female
of 70 with a house worth $400,000 and no existing mortgage.
Under the tenure option, she could draw $1256 a month. This
is the largest amount available from any of the 11 reverse
mortgage lenders who report their prices to my web site.
Alternatively, she could select
the largest credit line available from those lenders, which
was $224,280, and use it to purchase an immediate life
annuity from an insurance company. The largest such annuity
available from 9 AA-rated companies that report to
was $1349. Note that these purchases must be done in two
stages because part of the HECM credit line is not available
for 12 months.
Advantages and Disadvantages of the Two Approaches
While the HECM tenure annuity pays less than the life
annuity, the borrower retains ownership of the reserve
account underlying the annuity. This allows her to change
her mind after a few years and switch to a credit line for
the reserve amount still available. And if she dies early,
the remaining equity in her home goes to her estate. On a
life company annuity, in contrast, early death terminates
all payments unless the policy has a guaranteed payout,
which would reduce the annuity amount.
In addition, the HECM tenure annuity is guaranteed by the
Federal government. The life company annuity is only as good
as the promise of the insurance company, loosely backed by
state guarantee programs. Defaults on annuities, however,
are extremely rare.
On the other side of the ledger, if the borrower gets sick
and has to go to a nursing home, the HECM annuity will
terminate after a year of non-occupancy. That’s why it
is called a “tenure payment” rather than a “life annuity”.
The lender takes the house after the year and sells it, with
any equity remaining going to the borrower’s estate. With a
life company annuity, in contrast, the senior could be in a
nursing home indefinitely without shutting off the annuity.
Regulation of Life Annuity Purchases With HECM Funds
At an early stage in the evolution of the HECM market, some
seniors were induced to take out mortgages for the express purpose of
purchasing life annuities. The loan officers involved earned
two commissions, and the needs of the senior were often
disregarded. As a result, a law was passed that in effect
prevents a lender from disbursing funds at the closing that
will be used to purchase an annuity.
But the law is not an impediment to seniors whose retirement
plan includes the purchase of a life annuity from an
insurance company. They need only to take a HECM credit line
at closing, then draw on the line later to pay for the
annuity. This keeps the HECM transaction and the
annuity transaction separate, as they should be, and allows
the senior to shop for them separately.