Retirement planning in the 21st century presents unique challenges. Pensions are becoming increasingly rare, placing the responsibility of generating sustainable income and planning for longevity squarely on the shoulders of retirees. One of the most significant risks facing new retirees, often overlooked, is the “sequence of returns risk.” This blog post will explore this risk and demonstrate how a reverse mortgage, strategically utilized, can be a powerful tool to mitigate its impact and enhance your overall retirement plan.
Understanding Sequence of Returns Risk
Sequence of returns risk refers to the impact that the order of your investment returns has on your portfolio’s longevity, particularly during the early years of retirement. It’s a concept that highlights the vulnerability of retirees who begin withdrawing from their savings just as the market experiences a downturn. While market volatility is a reality for all investors, it poses a greater threat to those in the withdrawal phase of their financial journey.
Imagine two retirees with identical portfolios and withdrawal needs. Retiree A experiences negative returns in the first few years, while Retiree B enjoys positive returns. Even if both portfolios eventually achieve the same average return over the long term, Retiree A’s portfolio will likely be depleted much faster. This is because withdrawals during down markets force them to sell assets at a lower price, leaving less capital to participate in subsequent market recoveries. This highlights why its beneficial to work with financial advisor to help you manage your portfolio.
The Devastating Impact of Early Losses
The impact of negative returns early in retirement can be profound. These losses compound over time, significantly reducing the portfolio’s ability to generate income throughout retirement. Even if the market eventually rebounds, the damage done by those early withdrawals can shave years off your portfolio’s lifespan.
This is where a reverse mortgage line of credit comes into play, offering a potential solution to buffer against the effects of sequence of returns risk.
Reverse Mortgages: More Than Just a Last Resort
A reverse mortgage allows homeowners aged 62 and older to access the equity in their homes without selling or making monthly mortgage payments. Instead of making payments to a lender, the lender makes payments to the borrower, increasing the loan balance over time. This can be particularly helpful for retirees who want to supplement their income or cover unexpected expenses.
Contrary to popular belief, reverse mortgages are not just for individuals in dire financial straits. When used strategically, they can be a valuable tool for enhancing a well-crafted retirement plan.
Idea 1: The Strategic Line of Credit
One compelling strategy is to establish a reverse mortgage line of credit early in retirement, even if you don’t initially need it. The key is that the line of credit grows over time, providing a larger pool of funds available for future use. Consider it an insurance policy against market downturns.
Instead of drawing from your investment portfolio during a bear market, you can tap into your reverse mortgage line of credit. This allows your investments to recover without the added pressure of withdrawals, potentially preserving significant wealth over the long term.
Idea 2: Coordinated Withdrawal Strategy
A more proactive approach involves a coordinated withdrawal strategy. This means strategically using the reverse mortgage line of credit in conjunction with your portfolio withdrawals.
Here’s how it works:
- Review your portfolio’s performance annually.
- If the performance was positive, take your income from your portfolio.
- If the performance was negative, take your income from the reverse mortgage line of credit.
This approach allows you to protect your portfolio during down years, giving your investments time to recover without the added strain of withdrawals. The benefits of this strategy can be significant, potentially adding hundreds of thousands of dollars to your retirement savings over time.
Case Study Illustration
Consider a retiree with a $400,000 portfolio needing $28,000 annually, adjusted for inflation. If they experience negative returns early in retirement and continue to draw from their portfolio, they risk running out of money sooner than expected.
Using the coordinated withdrawal strategy with a reverse mortgage line of credit, this retiree could significantly extend the life of their portfolio and potentially leave a substantial legacy for their heirs. By pausing portfolio withdrawals during negative market years and utilizing the line of credit instead, the portfolio has the opportunity to rebound more effectively.
Is a Reverse Mortgage Right for You?
While a reverse mortgage can be a powerful tool, it’s not a one-size-fits-all solution. It’s crucial to carefully consider your individual circumstances, financial goals, and risk tolerance before making a decision. It’s a decision that should be made with a wise advisor, a financial planner, and possibly even your adult children.
Here are some key factors to consider:
- Age: Reverse mortgages are generally available to homeowners aged 62 and older.
- Home Equity: You need sufficient equity in your home to qualify for a reverse mortgage.
- Financial Needs: Assess your retirement income needs and determine how a reverse mortgage could potentially supplement your income.
- Long-Term Goals: Consider your long-term financial goals and how a reverse mortgage aligns with those goals.
Get Expert Advice
Navigating the complexities of retirement planning can be challenging. It’s essential to seek professional guidance from qualified financial advisors and mortgage specialists who can help you assess your options and make informed decisions.
At Stewardship, we have financial planners and mortgage advisors who are here to help. If you are 62 or older and are curious about a reverse mortgage, schedule an appointment to talk with a home loan advisor.
If you want a more comprehensive plan including investment management and retirement planning, schedule an appointment to talk with an investment advisor. Learn more about us and get directions to our office here: Google Business Profile