Increasing the Sustainable Withdrawal Rate using the Standby Reverse Mortgage

Transcription

1 Increasing the Sustainable Withdrawal Rate using the Standby Reverse Mortgage John Salter, PhD, CFP, AIFA Associate Professor, Texas Tech University Vice-President, Wealth Manager, Evensky & Katz Wealth Management Shaun Pfeiffer, PhD Associate Professor, Edinboro University of Pennsylvania Harold Evensky, CFP, AIF Research Professor, Texas Tech University President, Evensky & Katz Wealth Management 1

2 Increase the probability of meeting retirement goals. Increase the sustainable withdrawal rate. 2

3 Can we borrow from a reverse mortgage line of credit during times when the portfolio is off, in order to increase the probability of meeting goals and the sustainable withdrawal rate? 3

4 How much can be distributed from a portfolio in the first year of retirement, and subsequently increase the distributions by inflation, and have a reasonable chance of sustaining this spending throughout retirement? 4

5 Problems with reverse dollar cost averaging, the volatility drain on the portfolio when having to sell assets at depreciated prices. Annual returns, and sequence of returns can have a profound impact on the longevity of a retiree s portfolio. 5

6 Originally developed by Bill Bengen (1994). Subsequent research, using historical returns, estimated SWR to be near 6% using various factors such as spending rules and partial annuitization. 6

7 New research focusing on capital market expectations rather than historical returns significantly lower the SWR. New SWR projected to be as low as 2.5% 7

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9 What is your initial thought? Expensive? Last resort only? Was ours too What has changed? The product has become cheaper with the HECM Saver. Why use home equity? It is a resource that normally remains untapped. 9

10 Must Be age 62 or over. Pay taxes and insurance. Maintain home. Current mortgage must be paid off or rolled into HECM. Plans to be in home long term. 10

11 Must be primary home and currently lived in, can be out 365 consecutive days. Single family property, HUD-approved condo, or up to 4-unit home. No credit check required. Borrower must complete counseling prior to closing. 11

12 The amount of home equity available based on certain factors up to the home value limit $625,500. Think loan to value ratio, but home value in ratio capped at limit. 12

13 Calculated using following factors Type (*No longer two types) Standard vs Saver Age of the youngest borrower Older yields higher benefit Interest rates Lower expected rates (expected) yields higher benefit 13

14 Tenure- equal monthly payments for life as long as in home Term- equal monthly payments for a fixed period of time Line of Credit- unscheduled payments or in installments 14

15 Have similar costs to a traditional mortgage Title insurance, appraisal, attorney fees, etc, etc Other costs Mortgage Insurance Premium (FHA) Standard = 2% Saver =.01% *Now 0.5% Origination fee 15

16 No monthly principal or interest payment required Proceeds are tax-free Interest deductible when paid (and itemizing), interest payback is front loaded (Please consult a tax advisor) Benefit type can be changed 16

17 HECM (FHA insured) is non-recourse, the borrower or their estate will never owe more than the value of the home upon sale or death. The loan can not be called/cancelled as long as requirements are met. Unused line of credit grows over time. Can refinance if terms become better (upfront fees apply just as refinancing a traditional mortgage) 17

18 Changes have been made to the HECM program, notable changes are: Up-front MIP now 0.5% Exception if > 60% PLF is used in first year, then 2.5% PLF above SAVER, but under Standard Standards on ability to pay taxes and insurance 18

19 Misuse or ill advised use bad press Stigma of using the home value; debt Misconceptions I ll lose my home, bank owns home Mobility risk 19

20 HELOC Reverse Mortgage Line growth? No Yes Cancelable? Yes No Requires repayment? Yes No Age restriction? None 62 20

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22 Reverse dollar cost averaging Selling at specified periods from all assets. Problem: Volatility drain and transaction costs Income portfolios Using income producing assets to produce current income. Problem: Sensitivity to interest rates and reinvestment rate risk. Bucket strategies Various forms, logic is short-term needs in shortterm, liquid assets. Longer term needs in longerterm, growth assets. 22

23 A Two Bucket Strategy Cash Flow Reserve Account contains 2 years worth of living expenses. Investment Portfolio (Bucket) Refill when rebalancing, investment changes or forced sale if depleted Cash Flow Reserve Account (Bucket) Retirement Living Expenses 23

24 Cash Flow Reserve Account now contains 6 months worth of living expenses. Investment Portfolio (Bucket) Refill when rebalancing, making changes or when CFR account is depleted, portfolio acceptable Cash Flow Reserve Account (Bucket) Borrow when off and cash depleted Payback when back Standby RM (Bucket) Retirement Living Expenses 24

25 $600,000 Portfolio value over time. $500,000 $400,000 $300,000 Portfolio Value Distribution $200,000 $100,000 $

26 Our definition, and trigger for use (or borrowing) after analysis was: Below 80% the projected glidepath when needing to refill cash bucket borrow from RM. For example, if we expected our client to be at $500,000 next year based on our capital needs analysis, or 80% of this amount ($400,000) would be our trigger for borrowing under the strategy. 26

27 Similar to the use trigger, we investigated many payback triggers. Ultimately, after analysis, concluded payback trigger as being above 80% of the glidepath. 27

28 If portfolio above glidepath mark Refill cash when rebalancing, investment changes Cash bucket empty, refill from portfolio. LOC balance > $3,000 repay then refill. If portfolio below glidepath mark Have cash, need to rebalance, only rebalance Cash bucket empty, borrow from LOC 28

29 60% Equity (S&P 500) / 40% fixed income portfolio (intermediate bond index), correlated Non-taxable environment. Equity return 8.75%*, SD 21% Fixed income return 4.75%*, SD 6.5% Cash 3.5%*, SD 2% Transaction costs - $30 Up-Front HECM Saver Cost 3% of home value HECM Benefit as of June 2013 Lender margin 5% (no origination) 1-month LIBOR* Insurance 1.25% 29

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32 LOW PLF = 13% HIGH PLF = 53% 32

33 Sample Client: 62 years old, $250,000 home, $500,000 portfolio 33

34 Table 1: Plan Survival and Median Wealth for Current Interest Rate Environment Panel A: 50% Home Equity Cushion Survival Rate Median Wealth (000's) Home Equity (000's) Withdrawal SRM No SRM SRM No SRM % 92.3% 47.6% % 89.9% 41.0% % 85.9% 34.7% % 84.4% 29.4% % 79.1% 25.7% % 69.8% 22.1% % 64.5% 18.4% % 57.3% 15.7% % 51.0% 13.8% Panel B: 100% Home Equity Cushion % 99.8% 47.6% % 99.6% 41.0% % 99.2% 34.7% % 98.7% 29.4% % 97.9% 25.7% % 95.6% 22.1% % 94.2% 18.4% % 91.6% 15.7% % 88.1% 13.8%

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36 Importance of considering home equity! Increase the probability of meeting goals. Increase the sustainable withdrawal rate. Increase is dependent on rate environment (PLF) and home equity cushion. Lower rate environment yields higher SWR. Higher home equity cushion yields higher SWR. 36

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