How Your Home Can Function as a Pension Plan for Your Retirement

Ah, the good old days of defined benefit pension plans. Pensions used to be common and a wonderful source of retirement income. But these benefits are increasingly rare.If you are feeling the stress of funding retirement, it is likely because you simply lack the guaranteed pension income that your parents probably had.  You have worked hard, but the structure of our financial systems changed and you may be feeling like you don’t have enough cash for retirement. Find out how reverse mortgages can work as a replacement for pensions…

What is a pension and why was it so valuable?

A defined benefit plan is a type of pension in which an employer agrees to pay a specified monthly amount to the retired employee. Typically, this amount is predetermined using a formula based on the employee’s earnings history, age and tenure of service. So someone with a pension likely had three significant sources of retirement income: their pension payments, Social Security and personal savings. However, workers covered by a traditional defined benefit (DB) pension plan are all but extinct.  As of 2011, only 3 percent of all private sector wage and salary workers participated in a DB plan, according to the most recent data available from the Employee Benefit Research Institute.

How your home can be your own personal pension plan

For many people, housing wealth represents a sizable share of their overall net worth. But for retirees in particular, home equity is even more valuable. Home equity represents more than 50 percent of net worth for the typical household over the age of 65, according to research published in the Journal of Personal Finance. As a percentage of wealth, housing commands 80 percent of total wealth for roughly 30 percent of people above the age of 62. This is particularly good news for people who are struggling with how to pay for retirement. If you own your home, you may be able to use your home equity to create a kind of pension for yourself.

How does reverse mortgage work as a pension replacement?

For homeowners age 62 and older, a reverse mortgage can enable you to access a portion of your home equity, which you can use to increase cash flow during retirement. Unlike a traditional “forward” mortgage, monthly payments toward the loan balance are not required on a reverse mortgage. So rather than paying the lender each month, reverse borrowers are instead receiving funds from the lender. (It is important to note that although borrowers aren’t required to make monthly payments as they would on a conventional mortgage, they are still required to remain current on property taxes and homeowners insurance.) The money received from a reverse mortgage is considered a loan advance, and as such, it is not subject to state or federal income taxes.  As you borrow from a reverse mortgage and receive portions of your home equity, the loan balance increases. The amount of funds borrowed must be repaid at some point. Repayment of the loan is not required until the borrower dies or otherwise vacates the home secured by the reverse mortgage loan. Borrowers have the option to choose how they receive payments from a reverse mortgage, which can range from:

• A single lump sum disbursement
• A line of credit
• Monthly term payments for a specific period of time
• Tenure payments for as long as you live in the home

What’s unique about the tenure payment option is that it offers a payout similar to a pension plan.  You get monthly income guaranteed for as long as you live in the home.

Reverse mortgage tenure payments (your home pays you)

For retirees who intend to continue living in their home for as long as possible, the reverse mortgage tenure option might be worth considering. Similar to a defined benefit pension plan, the reverse mortgage tenure option makes monthly fixed payments to the borrower. With a pension, the pay period is typically for as long as the retiree lives, whereas reverse mortgage tenure payments continue as long as the borrower lives in the home secured by the reverse mortgage loan. Like other types of reverse mortgage payment options, the amount of loan proceeds a borrower may be eligible to receive depends on their appraised home value, interest rates, their age, and in the case of couples, the age of the youngest spouse. Many retirees have used loan proceeds obtained from a reverse mortgage to pay for a variety of needs, including medical expenses, home repairs and improvement projects, as well as other daily living expenses. Reverse mortgages are non-recourse loans, meaning borrowers—or their heirs—will never be required to pay more than their home is worth when the loan balance comes due. This means that even if the loan balance exceeds the value of your home, you will still receive the same monthly tenure payment. These payments only stop when you pass away or otherwise permanently leave the home.

Reverse mortgages vs. SPIAs

The reverse mortgage tenure payment is often compared to a Single Premium Immediate Annuity (SPIA), which in return for a lump sum payment, the insurance company promises to make regular payments for a chosen period of time—which is commonly for the remainder of the SPIA holder’s life, however long that may be. One advantage of the SPIA is that payments continue until the retiree dies, whereas with a reverse mortgage tenure strategy, payments continue only as long as the retiree lives in their home that has a reverse mortgage on it. For couples who can put plans in place to utilize home care (if needed) and keep their home as long as possible, the tenure option can be expected to provide payments for a duration similar to a SPIA, according to personal finance research from the University of Pennsylvania and Texas Tech University. While a reverse mortgage can afford retired homeowners the ability to age in place while also increasing their monthly cash flow, these loan products are not one-size-fits-all solutions to retirement planning. If you would like to know more about the different reverse mortgage payment options, and how much loan proceeds you may be eligible to receive—try using a Reverse Mortgage Calculator today.