Despite the poor reputation of reverse mortgages, research suggests these products can help to improve clients’ retirement sustainability.

Reverse mortgages are designed for older clients who want to access their home equity in order to boost spending during retirement. Unlike traditional loans, borrowers who are 55 years old or older don’t have to service the interest or repay the principal for as long as they own their home and are still living in it.

Although the conventional approach has been to keep home equity in reserve, integrating this illiquid asset into a framework for creating income in retirement greatly increases clients’ chances of meeting their spending objectives, maintains Barry Sacks, a tax planner in San Francisco, and his brother, Stephen Sacks, an economics professor at the University of Connecticut.

In a Journal of Financial Planning study entitled “Reversing the Conventional Wisdom: Using Home Equity to Supplement Retirement Income,” the Sacks brothers determined that the strategy’s principal benefit lies in reducing the impact of poor markets in the early years of retirement – known as the”sequence of returns” challenge – because the reverse mortgage strategy offsets the need to sell assets after a market decline.

What’s more, the payments from a reverse mortgage aren’t considered taxable income, and thus allow clients to deplete other retirement assets at a slower pace.

Rather than waiting until financial assets are exhausted and then taking out a reverse mortgage, the Sacks brothers looked at how matters would turn out if retirees tapped into their home equity earlier and delayed or reduced withdrawals from other assets.

The researchers compared three methods of drawing upon home equity: as a last resort, when savings are exhausted; at the beginning of retirement, thus giving investments more time to grow; and in the years following a negative return on investments, leaving room for a rebound.

If the retirement income withdrawal rate was set at an initial 4%, with the amount adjusted upward for inflation in each succeeding year, there was a 90% chance that investments alone would last through 30 years of retirement. When the withdrawal rate was increased, however, using a reverse mortgage significantly increased the chances of investments lasting that long.

Adopting a 6% withdrawal rate and using a reverse mortgage first or early provided an 80% probability of sustainable cash flow for 30 years. But using a reverse mortgage as a final resort provided only a 50% probability of not running out of money.

Similarly, taking a 6.5% withdrawal rate and using a reverse mortgage earlier produced a 70% probability of income survival for 30 years, while waiting resulted in only a 40% chance of an adequate income in retirement.

This increase in retirement income does not come at the expense of estate value, the researchers found. In a majority of cases, overall net worth remaining at the end of 30 years was greater when home equity was tapped earlier.

One caveat: U.S. homeowners with reverse mortgages in retirement can either receive a lump sum at the beginning and withdraw more later or have a line of credit from which to draw as needed. HomEquity Bank, the only national provider of reverse mortgages in Canada, does not offer a standby line of credit.

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