Standby Reverse Mortgages: A Risk Management Tool for Retirement Distributions John Salter, PhD, CFP, AIFA Associate Professor, Texas Tech University Vice-President, Wealth Manager, Evensky & Katz Wealth Management Harold Evensky, CFP, AIF Research Professor, Texas Tech University President, Evensky & Katz Wealth Management Shaun Pfeiffer Associate Professor, Edinboro University 1
Help our clients have a better chance of meeting their lifetime goals. 2
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. 3
Can we borrow from a reverse mortgage line of credit during times when the portfolio is off, in order to not sell in a bear market and better stay on path for a successful retirement? 4
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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. 6
Must Be age 62 or over. Pay taxes and insurance. Maintain home. Best to have little or no existing mortgage. 7
No monthly principal or interest payment required Proceeds are tax-free and can be paid in lump sum payment, monthly payments, line of credit or combination thereof. Interest deductible when paid (and itemizing). Please consult a tax advisor. 8
With a HECM Saver (FHA insured), the borrower or their estate will never owe more than the value of the home. The loan can not be called/cancelled as long as requirements are met. Line of credit grows over time. 9
There are costs to set up. Stigma of using the home value; debt. Misconceptions I ll lose my home, bank owns home Requirements not all will qualify 10
HELOC Reverse Mortgage Line growth? No Yes Cancelable? Yes No Requires repayment? Yes No Age restriction? None 62 11
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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. 13
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 14
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 15
Ultimately, after brainstorming and analysis, arrived at: Portfolio is off based on a retiree s projected portfolio glidepath. Glidepath the expected portfolio value over time based on planning (value after projected investment returns and distributions over time). 16
Where we believe our client needs to be over time to meet their goals based on our capital needs analysis. 17
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 would be our trigger for borrowing under the strategy. 18
Similar to the use trigger, we investigated many payback triggers. Ultimately, after analysis, concluded payback trigger as being above 80% of the glidepath. 19
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 20
62 year old retirees Withdrawal rate of 5% of initial portfolio, indexed with inflation (SWR methodology). Home value of $250,000 Portfolio value of $500,000 60% equity portfolio 33% PLF (avg LOC available of home value) Using 80% of glidepath as use and payback trigger. 21
60% Equity (S&P 500) / 40% fixed income portfolio (intermediate bond index), correlated Non-taxable environment. Equity return 9%* Fixed income return 5.2%* Cash 3%* Transaction costs - $30 Lender margin 2.25% (no origination) 1-month LIBOR* Insurance 1.25% *modeled within a distribution within a Monte Carlo simulation. 22
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Within the Monte Carlo analysis, there are simulations (futures) that result in a failing plan due to adverse, particular early, conditions (e.g. terrible early returns), even with this strategy. In this case, we would need to revise a client s spending plan, resulting in a new glidepath. This was not implemented in the analysis. This alteration would only improve the 24
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LOW PLF = 13% HIGH PLF = 53% 31
Strategy successful for 4, 5, and 6% withdrawal rates, and for multiple home to portfolio value combinations. We analyzed combinations of $250k and $500k home with $500k and $1,000k portfolios. Updating plan in failing plans can yield more successful outcomes. 32
PLF is impactful, higher the PLF, higher the available LOC, higher success rates. Same relationship applies to home value relative to portfolio size. Sensitivity to returns and LIBOR In terms of success/fail, LIBOR less impactful compared to returns. In terms of top and bottom deciles of success (wealth), returns and LIBOR are impactful. 33
Comparing to historical rates of return rather than modeled, strategy still has slight advantage, but traditional CFR strategy is negatively impacted by the assumption of lower return with similar standard deviation. 34
Similar simultaneous work on this subject was completed by Barry Sacks and Stephen Sacks, JFP February edition article. Their algorithm described in their paper, with its embodiment in a computer-based system for advising retirees on withdrawal amounts and sources, is the subject of a patent issued to the authors on November 8, 2011. However, their strategy used trailing returns as triggers, no payback, normal distribution, and no rebal or correlations noted. 35
CE Questions, Product Information, or Introduction to Local Reverse Mortgage Advisor: Phone: (866) 751-6112 Email: fp@genworth.com Tom Dickson Phone: (412) 580-5954 Email: tdicksonpgh@gmail.com 36