Planning for lifetime income
by Seth PearsonThe equity in your home can become the biggest solution to escalating health-care costs that threaten your financial well-being later in life.
It will require that you borrow from that equity on a favorable after-tax fixed rate. That may be a difficult psychological step – especially if you have devoted years to paying down your home mortgage and pride yourself on having no debt.
But being debt-free is not the same as being worry-free.
Today, a couple in which both spouses are 65 years old has a 50 percent chance that one spouse will live to age 92. And currently, more than one-third of those older than age 85 suffer from Alzheimer’s disease, a statistic likely to climb as more baby boomers age.
Health care costs are a significant threat for retirees. The Employee Benefit Research Institute projects that a typical 65-year-old couple will spend more than $216,000 on uninsured health care if they live to age 80; $440,000 if they live until 90; $778,000 if they live to 100.
The cost for a semiprivate room in a nursing home here on the Cape is approaching $100,000 a year.
Pre-funding your uninsured health-care costs could well mean the difference between the success or failure of lifetime-income planning. And your home equity may be the best source of that pre-funding.
Mortgage debt allows you to diversify into other investments and cushions the blow if local real estate values fall.
If the real estate market grows, having mortgage debt does not mean you give up those gains. Mortgage debt can be a hedge against risk, inflation and lack of liquidity. Fixed-rate mortgage interest today is near historic lows. Remember: To overcome the dangers of uninsured health-care expenses in retirement, you can use your strengths (home equity) to seize opportunities (such as low fixed-rate mortgages).
Tax advantages of reverse mortgages
Making your home pay you in retirement also comes with substantial tax advantages. Mortgage interest on your primary home and a second home used as a residence is tax-deductible up to $1 million. Home improvement debt also is tax-deductible – as is $100,000 of home equity debt borrowed for any reason.
Today’s fixed-rate reverse mortgages allow you to draw out the equity completely tax-free even though the house may have a very low cost basis.
There is no way to know what a diversified investment portfolio will earn in the future, so let’s apply what it earned in the past.
If you borrowed at 6.25 percent and deducted that interest, it might cost 4.5 percent after taxes. If you used the borrowed money to invest in a pre-funded health care account that earned 6.5 percent or more after taxes, you would gain 2 percent more a year.
What if that money was left in the house and it grew at 6 percent a year – or you invested it outside the house and had an 8 percent return?
Investing $100,000 at 6 percent over 30 years could grow to $574,349, while at 8 percent, it would grow to $1,006,266. That difference is why experts believe that home equity will be a huge, new solution to the health-care dilemma of living too long.
The following case studies for a couple, both age 65, may shed some light on funding a health care plan now.
1. A $100,000 reverse mortgage invested at 7.2 percent will provide $200,000 in 10 years and $400,000 in 20 years for health-care expenses. If the house continued to grow at 5 percent a year, the equity in the house would remain the same as it is today, even with the reverse mortgage debt.
2. A $200,000 reverse mortgage invested at 7.2 percent would provide $400,000 in 10 years and $800,000 in 20 years for uninsured home health care if needed.
3. The same couple could use a $100,000 line of credit at a fixed rate and pay the interest only using the tax-deductible interest deduction to draw money out of IRA accounts tax-free for the next 20 years.
4. A couple might use a reverse mortgage for $100,000 and use a line of credit for $100,000 to invest $200,000 today to fund future uninsured health-care expenses. Again, at 7.2 percent, it would provide $800,000 if needed in 20 years when the couple is age 85.
Of course, past performance is no guarantee for future returns. If your investment portfolio earns the same or more than the fixed-rate reverse mortgage, which is currently under 6.25 percent, then there has been no cost to this strategy compared with a long- term-care premium for a couple. A premium could cost $6,596 a year for life and only pay $85,000 for five years – or a total benefit of $425,000.
Accessing your equity through a reverse mortgage is an even better strategy if you wish hire caregivers and stay in your own home, or fund the costs as a private payer for a semiprivate nursing care facility.
Seth Pearson, CFP, is principal of Pearson Financial Services in Dennis and is the author of "The Two Million Dollar Gift: Dynasty Trusts. Why Leave Your Assets Any Other Way." He can be reached at (800) 385-7925 or seth@spearsonfinancial.com.
Published in Cape Business Health & Wealth July/August 2007
Seth Pearson Seth Pearson, CFP, is author of “The Million Dollar Gift” and has conducted numerous financial planning seminars. His firm, Pearson Financial Services, provides wealth management services and specializes in tax strategies for highly appreciated real estate. 
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