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Critiquing a Financial Plan

The following article examines five young people and their financial plan (more like their lack of planning).  They are then offered some preliminary advice about how to improve their situation.  Unfortunately, in every case I found the advice to be overly simplified.  Here’s the article

And here are some overarching strategies that apply to all the case studies:

1)      Emergency fund.  Start here first and make it a priority to build an emergency fund that can cover non-discretionary expenses for 3-6 months.

2)      Save more.  If you can’t save more now, earmark any future raise toward saving.  When asked about a rule of thumb for how much to save, I’ll often respond with “Save as much as you can”.  Young people and millennials are unlikely to have pensions and with the questionable future of Social Security, the burden to save is placed on their shoulders much more than previous generations.

3)      Automate.  Make sure any savings are set to occur automatically.  The mental anguish of writing a check every month or year to a retirement account can be surprisingly difficult.  Many times it is our own biases that create obstacles to reaching our own goal and simple processes like automating our savings can have a huge impact.

4)      Disability.  Life insurance is commonly discussed when a couple has children.  But disability insurance is rarely brought up.  What’s odd is that people are more likely to file a claim for disability insurance than life insurance.  And it doesn’t apply just to physical injuries, either.  We’ve had several clients and prospects tell us about their long term disability that affects their ability to do a desk job as a result of a bad car crash.

 

An Example of Using the New Reverse Mortgage

Imagine you have a retirement account valued at $1 million, where you take a monthly distribution of $3,000.  If the market (and your account) declined 30%, that monthly distribution will become a real strain on your account.  What was originally a 3.5% rate of withdrawal would increase to a risky 5.1% rate of withdrawal.

Now imagine the same situation, but that you had a reverse mortgage.  Instead of tapping your retirements account when it is down for the year, you took your monthly distribution out of the equity in your home, thus preserving the value in the 401(k).  Because the income received through the reverse mortgage is tax free, you could take out less than you would have from your retirement account (subject to any required minimum distributions).

In some of the research we are monitoring from the Journal of Financial Planning, we are seeing these coordinated withdrawal strategies as a significant tool to improve the probability of maintaining one’s current lifestyle through retirement. Research is showing that it can extend retirement spending out another 10 years or even more.

(Some readers may think about using a reverse mortgage to take equity out of their home to invest it in the stock market.  We strongly discourage that kind of thinking.)

Reverse Mortgages, like social security, annuities, life insurance, retirement accounts, and brokerage accounts, are all tools with good and bad features.  The ideas and research being done by the academics around reverse mortgages used in coordination with other tools are very promising.  In the next 5 years, I wouldn’t be surprised if the reverse mortgage concept became a common tool used in most retirement plans.

 

The New Reverse Mortgage Strategy

In a recent post, I tried to dispel some of the common myths surrounding reverse mortgages that have been written since April 2015.  In this post, I will explore how the Reverse Mortgage could be used.

Instead of thinking about a reverse mortgage as a last resort after all other assets have been depleted, think about it in conjunction with your other investments and working in tandem with your 401(k) or IRA and your other investments.

The basic premise behind a reverse mortgage is that it’s a product designed to tap an illiquid investment – your home.  For many Americans, it is still one of the biggest assets they own.  When it comes to using a reverse mortgage to tap the value of the home, there are four options:

1)      Lump sum payment

2)      Annuity-like stream of income guaranteed for as long as a borrower lives in the home.

3)      Fixed payment over a fixed number of years

4)      Line of Credit (that grows at a variable rate) that is accessible as needed

It’s option four, the line of credit, that has become most intriguing. The idea is to apply for a reverse mortgage in the early years of retirement and leave it alone for the most part.  You take on the line of credit long before you actually need it because the line of credit will grow over time.  If held long enough, the line of credit could exceed the value of the home.  The line of credit grows, even if the value of the home does not. But the homeowner or the estate would only be on the hook for at most 95% of the value of the home because a reverse mortgage is a “non-recourse” loan.

On top of the flexibility it brings, there are tax benefits too – draws from a reverse mortgage are not taxable.

(Some readers may think about using a reverse mortgage to take equity out of their home to invest it in the stock market.  We strongly discourage that kind of thinking.)

This is a compelling new tool that could provide innovative solutions for many retirees.  Research is showing that it can extend retirement spending out another 10 years or even more.

Whatever You Thought You Knew About A Reverse Mortgage You Should Forget

Whatever you thought you knew about a reverse mortgage you should forget.  Here’s why:

1)            The common strategy of using a reverse mortgage after all other retirement income options have been exhausted is a recipe for disaster. Dangling a carrot in front of an elderly couple or a widow saying “You can live in your home and we’ll even pay you” has misled many people who were shocked to learn that they still needed to pay their property taxes and maintain the house, even though they didn’t have the resources to do so.  In some cases, it resulted in the elderly couple being forced out of their home.  Bottom line, the timing strategy failed the client, not the mortgage itself.

2)            In 2013, the federal government enacted the Reverse Mortgage Stabilization Act which refined regulations around these products to make them better for the retirees.  The government stepped in to make sure the products are being used responsibly.  The provisions of “the act” were fully implemented by April of 2015. Reverse Mortgages written after that date are much different than the ones written earlier.

Reverse mortgages shouldn’t be thought of as a last resort.  Rather, it should be treated as a tool and component of an overall financial plan, which we will address in future posts.  Lot’s of academic research about how these products could actually enhance overall returns regardless of your financial situation, is happening as we speak.

How To Save, When You Can’t Save Today

“ I want to save for retirement, but I can’t afford to do so right now.”

This is a common complaint we hear, especially with our younger clients. They are dealing with debts, saving for their children’s education, and even helping to take care of their aging parents. These younger clients want to save for retirement but just don’t know what to do.

So, what should they do?

Over the last few months I have written about this concept extensively:
Is a Creative Saving Strategy Right For Me?
The Most overlooked Saving Strategy: The Serial Payment
The Three Flaws With The Most Popular Saving Strategy

The strategy that I outline is to come up with a plan to consistently save more and more every year. Perhaps you save an extra 1% of your paycheck each year, or every year allocate a portion of your raise to retirement. This concept is also referred to as Saving For Tomorrow, Tomorrow and there is a great Ted Talk about it here.

If you’re on board with this concept, visit this New York Times calculator to see how this could work for you: One Percent More Calculator

Einstein is claimed to have said that “Compounding interest is the eighth wonder of the world”. And by combining the benefits of compounding interest and compounding savings into a retirement plan, it would make for a much, much more powerful strategy.