Monthly Archives: September 2015

Holistic Financial Health (cont.) – More on Reverse Mortgages

The first time I met Barry Sacks was almost 20 years ago when he was brought in to help one of my clients solve a fiendishly complex tax/legal problem that had arisen in the bargaining between my client and its major Union. Arriving a few minutes late, he was clearly excited, but not about the tax issue. After some brief hello’s he told us about the brilliant idea he had for a new invention that occurred to him on the way over to the meeting. Pulling a single credit card from his overstuffed wallet, he asked us to consider all the wasted space (“real estate” as he put it) on the card that currently was taken up by a Bank logo and a background picture. Specifically, he asked, why couldn’t all that space be used to incorporate the information that all of the other cards in his wallet contained? Just like the “universal remotes” that were then all the rage in the electronics industry, he suggested that with his innovation, we all could have a “Unicard” that could be used for all the electronic transactions that we currently conduct, from department store purchases to borrowing books from the local library. As Barry waxed eloquent about all the convenience and financial efficiencies of such an invention as well as the easily surmountable technical challenges associated with its introduction, the client and I sat there both enthralled and a little taken aback at the unexpected turn the meeting had taken.

As I got to know Barry better I found that this incident was by no means an unusual occurrence with this curious and creative polymath. With a Ph.D. in physics from MIT, Barry had started his career in academia and was well on his way to becoming a tenured professor, when he suddenly decided that tax law would be much more interesting than electromagnetism and lecturing undergraduate students. He went back to law school and very quickly became one of the leading ERISA attorneys in the Bay area. By the time we met, he was a partner at one of  San Francisco’s boutique law firms and a specialist in the complex and unusual legal issues that often arise in the pension world. Many of these problems had actuarial aspects and, as a result, over the years Barry and I got to collaborate on a number of fascinating client projects.

Despite his demanding “day job”, Barry is an unapologetic “out-of-the-box” thinker who is constantly coming up with new ideas and new approaches to old problems. He currently holds several patents (not including his idea for the “Unicard,” which in some ways has been incorporated into smartphone technology) in fields ranging from physics to financial engineering, but his current passion is Reverse Mortgages and how this obscure, much maligned and poorly understood financial vehicle can be used in creative ways to not only augment one’s retirement income, but to become an integral part of a “decumulation” strategy after retirement.

In a previous post I mentioned how considering the value of your house (and any mortgage debt) as an integral part of your personal balance sheet is a key component of a holistic approach to financial health. Digging a little deeper, let’s now look at why and how a Reverse Mortgage Credit Line can be a powerful tool to unlock and utilize that value to ensure a financially healthy retirement.

A Reverse Mortgage Credit Line is actually nothing more than a loan against the value of your home. It operates just like a traditional home equity line of credit (HELOC) with two critical distinctions. First, unlike a HELOC, when you set up a Reverse Mortgage Credit Line, the amount you can draw down is not fixed, rather it grows every year, and not just with the increase in the value of your house, but at a stated annual rate. So, for example,  if you set up a Reverse Mortgage Credit Line for $200,000 at age 65 and don’t use it until age 75, by the time you start taking cash, the amount available might be $300,000 or even more. This in itself is a valuable way to assure yourself that you will have access to funds later in your retirement should you find your other sources of retirement income drying up, but the second difference between a HELOC and a Reverse Mortgage Credit Line is even more important; that is you don’t have to pay back the Reverse Mortgage until you sell or move out of your house, and you will never have to pay back more than the residual value of your house REGARDLESS of what the real estate market does

This second difference is what turns a Reverse Mortgage Credit Line from a source of “emergency funds” into a powerful retirement income generation tool that, when part of a sophisticated and highly effective decumulation strategy, can take you from a situation of having to worry about outliving your assets to a situation where you can comfortably draw down 6%, 7% or even 8% of your savings every year and still be confident that you have very little chance of running out of money before you die.

What is the magic? This is where Barry’s work comes into play. The technical details can be found at

https://www.onefpa.org/journal/Pages/Reversing%20the%20Conventional%20Wisdom%20Using%20Home%20Equity%20to%20Supplement%20Retirement%20Income.aspx .

In essence, what Barry discovered was that setting up a Reverse Mortgage Credit Line enables you to draw money from two sources, which can be coordinated.  That is, instead of drawing money every year from your 401(k), IRA or other retirement savings account, you draw from your retirement savings account only if the investment returns (in the prior year) on that account were positive, and draw from the Reverse Mortgage Credit Line if the account’s investment returns (in the prior year) on were negative.  This strategy allows the invested securities in the retirement savings account to better recover their values in the years following the years of negative returns than if they had been drawn on immediately following the negative returns.  It has been clearly demonstrated that if the negative investment returns occur in the early years of retirement, and the account is drawn on in the years following the years of negative returns, the likelihood of the account becoming exhausted in the later years of retirement is much greater than if the account is not drawn on immediately following the negative returns.  This coordinated strategy minimizes what is called the “sequence of returns” risk, associated with market volatility. In short, using this strategy allows you to draw on the account at a higher rate, for a longer time, than you otherwise might.

Some decisions don’t require the 5-step Present Value process and I believe that taking out a Reverse Mortgage is one of them. At first glance, the strategy above might seem like “smoke and mirrors” and that there might be hidden risks associated with the strategy (e.g. losing your house). However, as you will see in Barry’s paper, none of these potential risks are material. Try as I might, I can find no flaw or material risk in the strategy. In fact as far as I can see, unless the rules around Reverse Mortgages change in a pretty dramatic way, this is a winning strategy for holistic financial health that everyone who has a house and a 401(k) should seriously consider no matter what their personal rate of discount is.

Holistic Financial Health (cont.) – Present Value and Leaving a Legacy

I ended my last post noting that when we consider the future and determine our personal rate of discount we should not limit ourselves to the “rest of our life”. In fact, if you are like most people you care a lot (though maybe not quite as much) about what happens after you leave this world. Except for the very wealthy, very few of us (and even fewer financial planners) really take a hard look at what this implies for how we should manage our financial life both before and after we retire.

As a practical matter, when it comes to financial decisions, what this means is that  not only should you consider those scenarios where you don’t exhaust all your assets, but you should also think about other financial steps that you can take to leave something behind. In addition to your house there are two other mechanisms for leaving a legacy that are worth mentioning now and will be explored more deeply in future posts. The first is Life Insurance which many financial planners will likely suggest should be part of your financial strategy. As powerful and effective as it can be (for protecting your family while working, for generating retirement income, and for leaving a legacy) Life Insurance products are very complex, and purchasing policies as well as managing them well can be a daunting task.

The second and less well known vehicle that can be used to both generate retirement income and leave a legacy is a Charitable Gift Annuity (“CGA”), which even though considered a “Planed Gift” by the philanthropic community, can also be considered as a (not so traditional) retirement planning tool. Steve Vernon as well as many others have explained how effective annuities in general can be in ensuring your financial health. See for example Steve’s post at http://www.cbsnews.com/news/understanding-how-you-can-use-immediate-annuities-to-fund-your-retirement/  .

With respect to Charitable Gift Annuities, this link,  http://www.nolo.com/legal-encyclopedia/charitable-gift-annuities.html   can give you some basic information on how CGA’s actually work, but for now just know that CGA’s operate like any other annuity that you might buy from an insurance company except that instead of allowing a big corporation to make money on your purchase, the “profits” on a CGA go to the Charity that you got it from. You can obtain a CGA from almost any large not-for-profit organization, University or Charity. I purchased one from my old school, but many people get them from large Charities whose mission they believe in.

In order to get a CGA you must first make sure the Charity of your choice has a CGA program. To find out, just call them up and ask for their “Planned Giving “ department. After you transfer funds to the organization you have chosen, they will provide you (based on a legally binding contract) a guaranteed stream of payments starting either now or at some specified date in the future and those payments will continue for the rest of your life. The only difference between this and an annuity purchased from an insurance company is that in addition to the guaranteed lifetime income you get, you also receive an immediate tax deduction for the Present Value of what the Charity expects to recover from the transfer after you die and all of the annuity payments had been made.

In essence, obtaining a CGA allows you to provide yourself guaranteed retirement income, leave a legacy and get an immediate tax deduction for the profits that otherwise would have gone to an insurance company had you bought a more “traditional” annuity. To my mind a CGA is a great way to invest your retirement savings in a vehicle that can play an integral role in your decumulation strategy while at the same time benefiting a cause you believe in.

Of course it is not quite that simple (e.g. CGA’s can be expensive and tricky to obtain), and we will delve into more of the details in a future post. If you can’t wait, you can always read Chapter 12 of “What’s Your Future Worth?” and get the full story of my CGA purchase and take on the world of Planned Giving. In that chapter, as well as throughout the book, the message is the same – ask the experts for help in imagining the future and evaluating what might occur (steps 2 and 3 of the Present Value process), but don’t ever let others set your personal rate of discount (step 4)  by telling you how much (or little) value to place on what you get/give today vs what comes your way tomorrow or even in the distant future when you are gone but the world is still spinning and those you care about are still  around.

That is what holistic financial health is all about.