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Increasing the Sustainable Withdrawal Rate using

the Standby Reverse Mortgage

John Salter, PhD, CFP®, AIFA® Associate Professor, Texas Tech University Vice-President, Wealth Manager, Evensky & Katz Wealth Management

Shaun Pfeiffer, PhD Associate Professor, Edinboro University of Pennsylvania Harold Evensky, CFP®, AIF® Research Professor, Texas Tech University President, Evensky & Katz Wealth Management

Increase the probability of meeting retirement goals.

Increase the sustainable withdrawal rate.

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Can we borrow from a reverse mortgage line of credit during times when the portfolio is “off,” in order to increase the probability of meeting goals and the sustainable withdrawal rate?

How much can be distributed from a portfolio in the first year of retirement, and subsequently increase the distributions by inflation, and have a reasonable chance of sustaining this spending throughout retirement?

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Problems with reverse dollar cost averaging,

the volatility drain on the portfolio when having to sell assets at depreciated prices.

Annual returns, and sequence of returns can have a profound impact on the longevity of a retiree’s portfolio.

Originally developed by Bill Bengen (1994).

Subsequent research, using historical returns, estimated SWR to be near 6% using various factors such as spending rules and partial annuitization.

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New research focusing on capital market expectations rather than historical returns significantly lower the SWR.

New SWR projected to be as low as 2.5%

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What is your initial thought? Expensive? Last resort only?

Was ours too…

What has changed? The product has become cheaper with the HECM Saver.

Why use home equity? It is a resource that normally remains untapped.

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Must Be age 62 or over.

Pay taxes and insurance.

Maintain home.

Current mortgage must be paid off or rolled into HECM.

Plans to be in home long term.

Must be primary home and currently lived in, can be out 365 consecutive days.

Single family property, HUD-approved condo, or up to 4-unit home.

No credit check required.

Borrower must complete counseling prior to closing.

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The amount of home equity available based on certain factors up to the home value limit $625,500.

Think loan to value ratio, but home value in ratio capped at limit.

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Calculated using following factors Type (*No longer two types)

Standard vs Saver

Age of the youngest borrower

Older yields higher benefit

Interest rates

Lower expected rates (expected) yields higher benefit

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Tenure- equal monthly payments for life as long as in home

Term- equal monthly payments for a fixed period of time

Line of Credit- unscheduled payments or in installments

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Have similar costs to a traditional mortgage

Title insurance, appraisal, attorney fees, etc, etc…

Other costs

Mortgage Insurance Premium (FHA)

▪ Standard = 2%

▪ Saver = .01%

▪ *Now 0.5%

Origination fee

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No monthly principal or interest payment required

Proceeds are tax-free Interest deductible when paid (and itemizing),

interest payback is front loaded (Please consult a tax advisor)

Benefit type can be changed

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HECM (FHA insured) is non-recourse, the borrower or their estate will never owe more than the value of the home upon sale or death.

The loan can not be called/cancelled as long as requirements are met.

Unused line of credit grows over time.

Can refinance if terms become better (upfront fees apply just as refinancing a traditional mortgage)

Changes have been made to the HECM

program, notable changes are:

Up-front MIP now 0.5%

▪ Exception if > 60% PLF is used in first year, then 2.5%

PLF above SAVER, but under Standard

Standards on ability to pay taxes and insurance

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Misuse or ill advised use – bad press

Stigma of using the home value; debt

Misconceptions – I’ll lose my home, bank owns home

Mobility risk

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HELOC Reverse Mortgage

Line growth? No Yes

Cancelable? Yes No

Requires repayment? Yes No

Age restriction? None 62

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Reverse dollar cost averaging Selling at specified periods from all assets. Problem: Volatility drain and transaction costs

Income portfolios Using income producing assets to produce current

income. Problem: Sensitivity to interest rates and

reinvestment rate risk.

Bucket strategies Various forms, logic is short-term needs in short-

term, liquid assets. Longer term needs in longer-term, growth assets.

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A Two Bucket Strategy

Cash Flow Reserve Account contains 2 years worth of living expenses.

Investment Portfolio (Bucket)

Cash Flow Reserve Account (Bucket)

Retirement Living Expenses

Refill when rebalancing, investment

changes

or forced sale if depleted

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Cash Flow Reserve Account now contains 6 months worth of living expenses.

Investment Portfolio (Bucket)

Cash Flow Reserve Account (Bucket)

Retirement Living Expenses

Refill when rebalancing,

making changes Standby RM

(Bucket)

Borrow when “off” and

cash depleted

Payback when “back”

or when CFR account is depleted, portfolio

acceptable

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$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

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Portfolio Value

Distribution

Portfolio value over time.

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Our definition, and trigger for use (or borrowing) after analysis was:

Below 80% the projected glidepath when needing to refill cash bucket – borrow from RM.

For example, if we expected our client to be at $500,000 next year based on our capital needs analysis, or 80% of this amount ($400,000) would be our trigger for borrowing under the strategy.

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Similar to the use trigger, we investigated many payback triggers.

Ultimately, after analysis, concluded payback trigger as being above 80% of the glidepath.

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If portfolio above glidepath mark

Refill cash when rebalancing, investment changes

Cash bucket empty, refill from portfolio.

LOC balance > $3,000 repay then refill.

If portfolio below glidepath mark

Have cash, need to rebalance, only rebalance

Cash bucket empty, borrow from LOC

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60% Equity (S&P 500) / 40% fixed income portfolio (intermediate bond index), correlated

Non-taxable environment. Equity return – 8.75%*, SD – 21% Fixed income return – 4.75%*, SD – 6.5% Cash – 3.5%*, SD – 2% Transaction costs - $30 Up-Front HECM Saver Cost – 3% of home value HECM Benefit as of June 2013 Lender margin 5% (no origination) 1-month LIBOR* Insurance 1.25%

*modeled within a distribution within a Monte Carlo simulation.

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LOW PLF = 13% HIGH PLF = 53%

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• Sample Client: 62 years old, $250,000 home, $500,000 portfolio

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Table 1: Plan Survival and Median Wealth for Current Interest Rate Environment

Panel A: 50% Home Equity Cushion

Home Equity (000's) Withdrawal SRM No SRM SRM No SRM

250 5.00% 92.3% 47.6% 604 608

250 5.25% 89.9% 41.0% 535 608

250 5.50% 85.9% 34.7% 477 608

250 5.75% 84.4% 29.4% 300 608

250 6.00% 79.1% 25.7% 255 608

250 6.25% 69.8% 22.1% 376 608

250 6.50% 64.5% 18.4% 291 608

250 6.75% 57.3% 15.7% 192 608

250 7.00% 51.0% 13.8% 17 608

Panel B: 100% Home Equity Cushion

500 5.00% 99.8% 47.6% 1124 1217

500 5.25% 99.6% 41.0% 1027 1217

500 5.50% 99.2% 34.7% 939 1217

500 5.75% 98.7% 29.4% 734 1217

500 6.00% 97.9% 25.7% 685 1217

500 6.25% 95.6% 22.1% 793 1217

500 6.50% 94.2% 18.4% 787 1217

500 6.75% 91.6% 15.7% 750 1217

500 7.00% 88.1% 13.8% 709 1217

Survival Rate Median Wealth (000's)

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Importance of considering home equity!

Increase the probability of meeting goals.

Increase the sustainable withdrawal rate.

Increase is dependent on rate environment (PLF) and home equity cushion.

Lower rate environment yields higher SWR.

Higher home equity cushion yields higher SWR.

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