LTC Bullet:  Home Equity, Long-Term Care, and Retirement Income Security

Friday, April 27, 2012


LTC Comment:  Tap home equity first to maximize retirement income security?  So argues an interesting article in the Journal of Financial Planning, after the ***news.*** [omitted]


LTC Comment:  These days everyone is worried, especially boomers, about retirement income security.  The question “Will I outlive my savings?” gives rise to many worries. 

Can I afford to retire now?  How much longer should I work?  Will I be able to maintain my current life style?  What may I have to give up?  Could unlikely but predictable catastrophic expenses such as long-term care turn everything upside down?  What if this and what if that?

In more secure periods, the answers were pretty clear.  If you could draw down four percent of your savings per year and that was enough to live on adequately, you had a very good chance of making it through the next 30 years.  But lately, that formula is being challenged everywhere.  Furthermore, a large and growing percentage of aging Americans cannot manage for long on the combination of their savings plus Social Security at any draw down rate no matter how high.

Add to those problems the increasing vulnerability of the social safety net, likely increased means-testing of Medicaid, Social Security and Medicare, and doubtful private investment returns.  Where can people turn?

More and more we see home equity mentioned as a private retirement security safety net.  Certainly home equity is the biggest asset most people possess, especially older people.  This remains true even after the much-touted “collapse” of home values. 

But the home has always been sacrosanct before.  Our WWII generation paid off their mortgages and held on to their homes tenaciously as sanctuary in old age and their principal legacy to heirs.  Medicaid exempted the home and all contiguous property from long-term care liability with no limit until 2005 and up to $525,000 (37 states) or $786,000 (13 states and DC) currently.

But home equity is no longer untouchable.  To survive, Medicaid will likely be forced to reduce its home equity exemption radically.  That will put home owners at far greater risk for long-term care expenses than heretofore.  This is a risk few have anticipated but many will face.  Even if they dodge expensive long-term care, however, many boomers will need to use their home equity just to make ends meet.

So, a big question people need to ask is:  “What’s the best way to put home equity to use for retirement security?”  That is the question the following article from the Journal of Financial Planning attempts to answer.  Check out the excerpt provided below, follow the link to the full article, consider its provocative conclusions and ask some additional questions it does not address, such as:

What role should home equity play in financing quality long-term care for aging boomers?  Should Medicaid, a means-tested public welfare program, protect home equity from long-term care risk?  Wouldn’t it make more sense for home equity to help pay for long-term care through reverse mortgages?  Couldn’t supplemental income from home equity conversion make LTC insurance more affordable for more people thus protecting all their wealth:  savings and home equity?  Much to ponder.


Excerpt (footnotes omitted) from Barry H. Sacks, J.D., Ph.D., and Stephen R. Sacks, Ph.D., “Reversing the Conventional Wisdom:  Using Home Equity to Supplement Retirement Income,” Journal of Financial Planning, April 2012;

“Executive Summary

  • This paper examines three strategies for using home equity, in the form of a reverse mortgage credit line, to increase the safe maximum initial rate of retirement income withdrawals.
  • These strategies are: (1) the conventional, passive strategy of using the reverse mortgage as a last resort after exhausting the securities portfolio; and two active strategies: (2) a coordinated strategy under which the credit line is drawn upon according to an algorithm designed to maximize portfolio recovery after negative investment returns, and (3) drawing upon the reverse mortgage credit line first, until exhausted.
  • A three-spreadsheet stochastic model is described, with one spreadsheet incorporating each strategy. The three spreadsheets are run simultaneously, with the same investment performance and withdrawal amounts in each. The cash flow survival probability over 30 years is determined for each strategy, and the comparisons are presented graphically for a range of initial withdrawal rates. We find substantial increases in the cash flow survival probability when the active strategies are used as compared with the results when the conventional strategy is used. For example, the 30-year cash flow survival probability for an initial withdrawal rate of 6 percent is only 55 percent when the conventional strategy is used, but is close to 90 percent when the coordinated strategy is used.

“The model also shows that the retiree's residual net worth (portfolio plus home equity) after 30 years is about twice as likely to be greater when an active strategy is used than when the conventional strategy is used.

“The overriding objective for many retirees is to maintain cash flow throughout their retirement years, to avoid ‘running out of money’ in their later years. Cash flow survival is the central theme of this article.

“Although more than half of retirees age 65 and older (64 percent) get at least half of their retirement income from Social Security, there is a significant portion of the population of retirees whose primary source of retirement income is a portfolio of securities, often in a pre-tax account such as a 401(k) plan or a rollover individual retirement account (IRA). We will refer to any such account, whether pre-tax or after-tax, as an ‘account.’

“It has long been accepted that the maximum safe (or ‘safemax’) annual withdrawal from an account begins with a first year's withdrawal equal to between 4.0 percent and 4.25 percent of the initial portfolio value. Subsequent years' withdrawals then continue at the same dollar amount each year, adjusted only for inflation (thus maintaining constant purchasing power). In this context, the term ‘safe’ means a 90 percent or greater probability that the account will have sufficient assets to make such annual payments for at least 30 years.

“Many retirees find that the safemax amount of annual withdrawal is uncomfortably limiting and therefore tend to draw more than that amount. This article considers three strategies for coping with the economic risk, the risk of exhausting cash flow, that derives from taking withdrawals in excess of the safemax amount.

“The three strategies considered all involve the use of home equity as a supplement to withdrawals from the account. The conventional wisdom holds that home equity, drawn upon in the form of a reverse mortgage (discussed below) or similar product, should be used as a last resort, only if and when the account is exhausted. This is a rather passive approach. We show that the probability of cash flow survival is substantially enhanced by reversing the conventional wisdom. In particular, we show that cash flow drawn from home equity using either of two more ‘active strategies,’ in conjunction with withdrawals from the account, yields cash flow survival probability substantially greater than the more passive approach of using home equity as the last resort (the ‘conventional strategy’).

“One of the active strategies is quite simple: a straightforward reversal of the conventional wisdom. In this strategy, a reverse mortgage credit line is established at the outset of retirement, and the credit line is drawn upon every year to provide the retirement income until it is exhausted. Only after the reverse mortgage credit line is exhausted are withdrawals taken from the account. This is the ‘reverse-mortgage-first strategy.’

“The other active strategy is more sophisticated. It also uses a reverse mortgage credit line, but withdrawals from the credit line are taken in some years and not others. The withdrawals are taken according to an algorithm described later in this paper. Because the algorithm consists of coordination between the account and the line of credit, this strategy is termed the ‘coordinated strategy.’”