Small change to Federal Tax Code could greatly benefit cash-strapped retirees without loss of tax revenue

This proposal focuses on retirees who own their homes but have little or no financial assets. They are said to be “rich in house but poor in money”. As a rough estimate, they may be 15 million. A small change in the federal tax code would help them not reduce federal tax revenue and increase revenue in some states.

With their wealth largely or entirely in their home, there is only one way for these retirees to convert that wealth into usable funds that will last a lifetime, while still staying in their home: take out a reverse mortgage. HECM. For example, a 65-year-old retiree who has no financial assets but owns a $ 500,000 home may receive an HECM occupancy payment of approximately $ 1,083 per month as long as he or she lives in the home. House.

But there is a better option which is not used. By taking an HECM line of credit and using it to purchase a deferred annuity, a combination of monthly line of credit withdrawals and annuity payments after the deferral period provides larger payouts than a term payment. life of the retiree.

This is illustrated by the table, which applies to the retiree mentioned above. The lowest horizontal line (blue) is the tenure payment of $ 1,083. The top horizontal line (red) at $ 1,246 is the combination of an HECM line of credit and an annuity. A portion of the line of credit is used to purchase an annuity with payments beginning after 10 years. The balance of the credit line is used for monthly drawings for the first 10 years.

[Note: The prices used for tenure payments and credit lines are the highest quoted by any of the lenders who report their prices to The Mortgage Professor website, while annuity prices are the best of those with A-ratings or better. Prices are as of February 2, 2021]

The line of credit / annuity combination has other advantages over payment for seniority. Seniority payments cease if the borrower leaves home, while annuity payments continue for life even if the retiree has to leave their home for health or other reasons.

In addition, the HECM / annuity combination may include an adjustment to the cost of living, which is shown in the graph with an increase of 2% (green line). Increasing payouts in coming years are made possible by lower payouts in the early years, as well as the mortality-driven decline in the number of retirees receiving payouts. It is also likely that larger payouts on the combo will result in fewer tax defaults, which would reduce claims against the HUD reserve account.

However, insurers today view reverse mortgage funded annuities as “inappropriate” and will not accept them. As a result, today’s retirees can only use the line of credit / annuity combo through subterfuge. A specified retiree can place the funds drawn on the line of credit in a bank deposit or investment account and then cite that account as the source of funding for the annuity. Such cases are very rare.

One of the main reasons insurers view reverse mortgage funded annuities as “inappropriate” is that it means a shift from untaxed payments to imposed payments. [Under current Federal tax rules, an annuity purchased with HECM reverse mortgage proceeds would be treated as a “non-qualified” purchase, which means that annuity payments to the retiree in excess of the premium paid would be taxed as ordinary income].

The adequacy concerns would largely disappear if the federal tax code were amended to eliminate taxes on annuity payments that had been funded entirely by reverse mortgages. Indeed, this modification of the tax code would give a federal sanction to the HECM / annuity combinations. There is also precedent for such action: 4 of the 8 states that currently tax annuity payments exempt annuities purchased with funds from IRAs, 401Ks, and 403bs.

In light of the monumental problems facing the federal government today, why bother with this one? Because millions of Americans are fast approaching retirement with their wealth largely or entirely in their home equity. Treating HECM-funded annuity payments as tax-free could increase the funds available to these hard-pressed retirees at a time in their lives when those dollars matter most. There would be no loss of federal tax revenue as the number of line of credit / annuity combinations currently underwritten is negligible. And because the tax exemption would result in the purchase of more annuities, there would be an increase in income in the 8 states that now tax annuity premiums.

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