Which is worse with respect to sustaining retirement income: sacrificing potential investment portfolio growth early, or exposing mortgage debt to interest rates later? In his November 2015 paper entitled “Incorporating Home Equity into a Retirement Income Strategy”, Wade Pfau simulates different strategies for incorporating home equity into a retirement plan (both income assurance and legacy) via a Home Equity Conversion Mortgage (reverse mortgage). A reverse mortgage is a non-recourse loan that enables many U.S. homeowners to tap (untaxed) up to $625,000 of home value. The different strategies are:
- Ignore Home Equity: A baseline not comparable to the other strategies.
- Home Equity as Last Resort: Delay opening a reverse mortgage line of credit until the investment portfolio is exhausted.
- Use Home Equity First: Open a reverse mortgage line of credit at the start of retirement and draw upon it first, letting the investment portfolio grow.
- Sacks and Sacks Coordination Strategy: Open a reverse mortgage line of credit at the start of retirement. Draw upon it (until exhausted, with no repayments) only after years when the investment portfolio loses money.
- Texas Tech Coordination Strategy: Open a reverse mortgage line of credit at the start of retirement. Draws upon it (until exhausted) when investment portfolio balance falls below an estimated 80% of a required wealth glidepath. Pay it down when investment portfolio balance rises above an estimated 80% of required wealth glidepath.
- Use Home Equity Last: Open a reverse mortgage line of credit at the start of retirement. Use it only after the investment portfolio is exhausted.
- Use Tenure Payment: At the start of retirement, implement a reverse mortgage tenure payment (life annuity) option, with the balance of annual spending drawn from the investment portfolio.
For each strategy, he runs 10,000 Monte Carlo simulations of a 40-year retirement based on historical annual distributions of 10-year bond yield, equity premium, home appreciation, short-term interest rate and inflation rate. Annual withdrawals and investment portfolio rebalancings (to 50% stocks and 50% bonds) occur at the start of each year. Assuming initial home value $500,000, initial tax-deferred investment portfolio value $1 million, annual withdrawal 4% of initial investment portfolio value ($40,000, subsequently adjusted for inflation) and marginal tax rate 25% for investment portfolio withdrawals, he finds that: Keep Reading