Challenges and Strategies for Financing an Increasingly Long Life

A research paper that came out in October 2016, and was presented last week at the Society of Actuaries Living to 100 Symposium, recommended reverse mortgages as part of a combination of strategies.

Challenges and Strategies for Financing an Increasingly Long Life 
Funded by: Society of Actuaries
Authors: Vickie Bajtelsmit (Colorado State University), Anna Rappaport (Consultant, “Strategies for a Secure Retirement”) and Tianyang Wang (Colorado State).

Research funded by the Society of Actuaries shows that a combination of post-retirement risk management strategies can improve the financial outcomes for longevity. Among the strategies is a reverse mortgage: For couples who own a home at retirement and do not have an outstanding mortgage, a reverse mortgage can improve financial well-being in retirement. The reverse mortgage produces life income that reduces the need to tap other financial resources, but also reduces home equity that could be needed to meet future needs. (Table 15)

Reverse mortgages:
We find that reverse mortgages have a beneficial effect, significantly reducing the amount of wealth needed at retirement. Based on our simulations, the amount of non-housing wealth needed at age 66 can be reduced by from 17% to 26%, depending on the income level and retirement age. For example, the higher income couple in the base case needed $880,000 to retire successfully at age 66 with 90% confidence.

If they take a reverse mortgage at the time of retirement, the amount of non-housing wealth needed is reduced by about $150,000. If they plan to retire at age 70 and take a reverse mortgage at that time, the amount of wealth needed to be 90% confident of meeting all of their expenses goes from $610,000 to $450,000. Delaying the timing of the reverse mortgage results in a larger annuity payment for the household but decreases the expected number of payments. In addition, the household will have to cover any income shortfalls between the date of retirement and the onset of the annuity payments.

As a result, we find that the optimal timing of the reverse mortgage, based on the simulated wealth needed in these scenarios, is at the date of retirement (or possibly in the first year in which expenses exceed retirement income).

There are two issues that should be noted regarding this result. Under current rules, the loan-tovalue ratios for reverse mortgages are low enough that the household continues to have significant equity in their home and can benefit from increases in home value throughout their retirement period. In general, the reduction in wealth needed is less than the actual housing wealth that is being mortgaged. This reflects both the cost of the mortgage itself and also the risk that is being taken on by the financial institution.

The annuity itself is fixed and is not assumed to have a guaranteed number of payments option. Therefore, as with any life annuity, short-lived households will get a worse “deal” on this strategy, but the benefit to long-lived households of receiving more years of annuity payments is eroded by inflation. When we consider the financial effects of reverse mortgages by longevity tercile, the longest-lived households see the greatest reduction in wealth needed.

Major Conclusion:
A major conclusion from this research is that the risk of living long should be more carefully incorporated in household retirement planning. Most people, if they plan at all, appear to anticipate an average life span. The reality is that one-third of married couple households will have at least one spouse live to age 92 and, as compared to those with average lifespans, it will take substantially more wealth to maintain the pre-retirement standard of living through to old age. Financial products that provide lifetime income or that cover specific future expenses can help households have more successful post-retirement periods.