If you or your parents have lived in your home for many years and have built up a lot of equity in the property you may have heard about or considered a reverse mortgage as a potential source of income during retirement. There seems to be a wide divide in opinions on whether reverse mortgages are a wise way to leverage equity in a home or a detrimental financial move for living out the golden years.

According to financial advisor Paul Escobar of U.S. Wealth Management, when it comes to reverse mortgages, “Seniors and their advisors should consider them, especially when their sole income and asset is their house.” Today we’ll take a look at how a reverse mortgage works and the benefits they have to offer retirees and seniors.

What is a Reverse Mortgage

A reverse mortgage is the direct opposite of a traditional mortgage because the mortgage lender makes monthly payments to the homeowner. A reverse mortgage is an option available to homeowners that are 62-years of age or older that own a primary residence free and clear of any mortgages or liens. The home also has to have a sufficient amount of equity—what is deemed as sufficient varies by the lender.

There may be other requirements from the lender but credit does not play a role in the qualification process. When homeowners qualify, the mortgage payments can be taken as a lump sum or in monthly installments. Since the amount of the reverse mortgage is based on the amount of equity, interest rate and the borrower’s age, the amount of the mortgage can vary.

Reverse Mortgage Benefits

While all reverse mortgage holders have their own reasons, there are some popular reasons that seniors opt for a reverse mortgage. Jason Roberts of Frost Lending Group points out that the fees for a reverse mortgage are similar to a conventional loan and the interest rates for reverse mortgages are generally lower. He’s helped a range of clients with reverse mortgages—some couldn’t pay for their basic needs, while others had a decent amount of savings but wanted to eliminate their mortgage payment. 

Retirement

Medical Expenses 

Increased cost of living, rising healthcare costs and a decreasing income do not necessarily work in harmony, but is the situation that leads many retirees to a reverse mortgage. Rather than forcing retirees to choose between paying their living expenses and paying for medicine and healthcare, the extra money that reverse mortgage provide allow seniors to pay for all of their needs—medical and daily living.

Home Accommodations

Some retirees use the money from reverse mortgages to make necessary modifications to their home. It may be widening doorways to accommodate the use of a walker or wheelchair or building a ramp to get up and down the stairs. Reverse mortgage payments can cover these costs.

Extra Money

With more time to travel and participate in leisurely activities, money from a reverse mortgage can provide extra spending money. It pays for trips, vacations or activities such as golf and days at the spa. It is an added bonus that allows them to enjoy some of the luxuries in life.

Go Debt Free

With another source of income for normal living expenses, many retirees use reverse mortgages to reduce or deplete debt. Without debt, the reverse mortgage money becomes additional cash flow that can be applied to other expenses.

After a discussion in her own mind and with her daughters, 77-year-old Francine Trevins opted for a reverse mortgage on her Manhattan loft. Francine says she has a wonderful life now because she is relieved of the “burden of a mortgage.” Her only concern is outliving the mortgage amount.

When it’s Right

Whether a reverse mortgage is right is different for each person. Talk with your financial advisor, tax consultant and estate attorney to go over the specifics of your situation. Don’t make a decision on what someone else has done because situation-specific reasons why reverse mortgages work or not vary too much.

Some of the questions you want to answer:

• Is there family you want to leave the home to?
• Do you have sufficient income to live out your retirement years?
• What plans do you have for retirement? Continue to work part-time? Travel?
• How old are you?
• Is there equity in the home? Is your home paid off?
• Do you have other sources of income?

Reverse Mortgage Dangers

Even the experts agree that there are drawbacks to reverse mortgages in some situations. In a future article we’ll take a look at the potential dangers of reverse mortgages and what to look out for.

Do you ever ask yourself why you’re being such a stickler with your money? We save and invest money for “the future” but how do we know when that future we’ve been preparing for becomes the present?

My Grandmother’s Apartment

My kids and I paid an evening visit to my grandmother this week, just so they could spend a few hours hanging out with her.  The memory of my grandfather, who passed away last year, still fills her relatively new apartment.  She moved into the independent living community after he died and as I walked in the front door I realized how people know when “the future” has arrived.

The place she’s living is wonderful. They have a computer room, a chapel, a game room, a workout room, a movie theatre, shuttles to drive the residents around town, a great dining facility, and most importantly… a nice community.  The people that live there congregate for meals, movies, games, worship, and just to visit.

The Future is Now

Of course all of these amenities aren’t cheap but it’s okay because “the future” that my grandfather saved for all those years has arrived.  As I mentioned in my memorial to him, my grandfather was tight with money, and proud of it.  Now all that saving and investing is paying off. Providing for his wife when he’s not there to care for her is EXACTLY what that money was meant for. 

He probably couldn’t visualize exactly how the money would be spent at the time of earning and saving it but he knew he was investing in the security of his family.  He didn’t know what the future held but he knew that it would eventually come and that he wanted to be ready when it did.

Condolences

One of the reasons I wanted to write this was because of Jason over at Frugal Dad who sadly lost his mother last Sunday. My visit to my grandma and his loss of his mom really got me thinking about where my parents and someday my wife and I will end up. 

I don’t know when that future will be. I don’t know what it will look like. But I’m glad that my parents and my wife and I are saving for the day when it arrives so that we can provide the rest of our family the security that we won’t be there to give.

The Roth IRA conversion rules are changing in 2010, here are a few things to consider if you’ve been thinking about converting your traditional IRA to a Roth IRA.

Roth IRA Conversion Limits

The current IRS rules only allow you to convert your traditional IRA to a Roth IRA if your modified adjusted gross income is $100,000 or under. Next year that income limitation will be removed so you can convert to a Roth IRA regardless of your income in 2010.

IRA Conversion Taxes

Converting from a traditional IRA to a Roth doesn’t allow you to skip out on the taxes you owe.  You still have to pay income tax on the amount you convert into your Roth IRA.

However, if you convert your traditional IRA in 2010 you can delay reporting of the income over a two year schedule.  The rules allow you to defer 50% of the income to 2011 and the other 50% until 2012.

If you don’t have the money to pay the taxes you’ll owe, it’s probably not worth it to convert your traditional IRA to a Roth IRA until you have the funds. If you pay the taxes with funds from your IRA you’ll be missing out on the tax-free growth of the funds you withdraw.  In addition if you’re under 59 1/2 you’ll proably also have to pay a penalty.

Retirement Tax Brackets

If you think your tax bracket will be lower in retirement than it is now then the taxes you would pay when converting to a Roth IRA next year could be higher than what you would pay when widthdrawing from a traditional IRA if you decided not to convert it.

Of course no one knows for sure what their income will be in retirement so this decision has to be made based on assumptions about your financial situation in the future.

Retirement planning can be daunting. You make a lot of assumptions about where you’ll be financially decades down the road.  You assume that the tax laws won’t do anything crazy and that the financial markets will continue to operate as they have for decades.  You also debate whether Social Security funds are going to shrivel up and blow away by the time you’re ready for them.

Although retirement planning is not simple it’s still very necessary to help give you some financial security in your later years.  The Obama administration made some proposals in their weekly address that are intended to help with retirement savings and education.  Here they are:

1) Allow employees of small businesses to automatically enroll in a 401(k) or an individual retirement account.

2)  Offer the option to receive your federal tax refund as a savings bond.

3) Enable employees to put payments for unused vacation and sick days into their retirement plan if they wish.

4) Retirement Planning Education. The IRS and the Treasury Department are working on a simplified guide and website to help translate the financial rules into a format that’s easier to understand.

I think finding ways to allow small businesses to let their employees automatically put money into a retirement account is a good idea.  The savings bond for your tax refund sounds good, I wonder how many people will actually do it?  I would love to put my unused sick days towards my retirement plan but I wonder how much that will cost companies and what impact that will have on them.  I don’t think financial education is a bad idea but I wonder how many people will make use of the site and how much it will cost to build and promote it.

What are your thoughts on the retirement savings and education proposals?

Traditional IRA or a Roth IRA, which should you open? This is a common question that comes up with many people looking to open an individual retirement account (IRA). I’ll try to make this as concise as possible, and let you decide for yourself which IRA is best for you.

Traditional IRA

Definition: A traditional IRA is a tax-deferred retirement fund, and the contributions may be tax deductible depending on your income and tax filing status. The contributions are made on a pre-tax basis.

Income Restrictions: There are no income restrictions for the traditional IRA. Everyone can contribute to a traditional IRA, but not everyone can deduct the contributions on their taxes based on your level of income.

Withdrawals and Distributions: Withdrawals can be made starting at age 59 1/2, but they cannot be made before that without incurring a penalty. Distributions are required to be made at 70 1/2 years old. This is the FAQ from the IRS about required minimum distributions.

Advantages: The advantages all depend on how much you plan on being worth when you are in your retirement years. If you think that you will have more taxable income during your working years or you make too much money to qualify for a Roth IRA, then a traditional IRA is the right choice for you. The biggest advantage is that you can reduce your taxable income during your working years.

Disadvantages: If you are a great saver, and your IRA distributions end up becoming higher than the income in your working years, then you could end up spending more in taxes during retirement than the money you saved in taxes from your contributions.

Roth IRA

Definition: A Roth IRA is a tax-exempt retirement fund, and contributions are made with after-tax income. Contributions are not tax deductible, but the distributions in retirement are tax free.

Income Restrictions: Single tax filers cannot earn a gross income of more than $95,000 and married tax filers cannot earn more than $150,000.

Withdrawals and Minimum Distributions: Like the traditional IRA, the minimum age to start wthdrawing funds is 59 and a 1/2 years old. The principal amount can be withdrawn at any time, if you take out earnings early you will incur a steep penalty. The Roth has no minimum distribution requirements.

Advantages: The biggest advantage is not worrying about taxes during retirement. If you will earn more in retirement distributions than you do during your working years, then the Roth IRA is for you. Also, not being required to make minimum withdrawals is a very nice thing.

Disadvantage: Contributions are not tax deferred so you don’t lower your income taxes for the year you make the contribution. Not everyone qualifies for the Roth IRA, so high-income earners don’t have the option of opening one.

Traditional IRA or Roth IRA? Not only should you calculate how much income you think you’ll have in retirement vs today, you also have to consider how tax laws will change over time.  It’s hard to know what the tax code will look like decades from now when it’s time for you to retire.  There’s been a lot of talk about tax reform lately but no one really knows when or if it will happen.

Some people think that taxes will inevitably be higher across the board in the future to help fund social programs like Social Security, Medicaid, and Medicare.  Others believe that the US government will keep tax rates relatively low and won’t adopt the high tax rates that many European countries use.

Opening an IRA

Whichever you decide, be sure to talk with your financial advisor about the advantages and disadvantages before you open an account.

Below are a few good places to open an IRA:

• Vanguard
• Etrade
• TradeKing

Death. No one wants to think about, especially a newly married couple. However, thinking about the worse case scenario is an essential trait for maintaining a sound financial plan. There’s no scenario worse than the death of you or your spouse, and that is why you need to prepare for it.

When Should You Buy Life Insurance?

Here are some scenarios where you might want to protect your family with life insurance:

• If you buy a house together as a couple, buy life insurance. If one of you dies, then the other can take the death benefit and either pay off the house or invest it and pay the payment with the monthly interest that it earns.
• When you have kids. If you both die together in a car accident, you need to leave money behind for your children to live a happy and fulfilling life.
• When one spouse is a stay-at-home parent. If the primary income earner dies, the other spouse MUST be left with a death benefit to cover monthly expenses.

What Type of Life Insurance Should You Buy?

For a younger couple in these situations I would recommend level term life insurance. I think cash value life insurance such as whole life, variable life, and universal life insurance are horrible products for the consumer.  They attach a cash value account with a death benefit.  The problem with these products is that the investment accounts attached to these policies typically yield low returns and come with VERY high management fees. 

Honestly, these products only make life insurance agents richer, not you.  This is why many financial advisors and life insurance agents recommend these products, because they offer a higher commission than term life products.  Term life insurance is only a death benefit of a specified amount for a level amount of time, and the premium is VERY cheap for healthy individuals. 

For instance, I just looked on Zander Insurance for an instant term life quote, and I can purchase a 20 year policy for $750,000 for $342 bucks a year!  Don’t use a life insurance policy for your retirement investing.  Designate mutual funds, index funds, and real estate for your retirement nest egg.

How Much Should You Buy?

Buy 8 to 10 times of your yearly income. So, if you make $50k a year, then you should buy $400k to $500k in term insurance. The idea here is that your spouse could take that money, invest it in good mutual or index funds, and replace your monthly income with the monthly interest from the lump sum death benefit.

Where Should You Buy It?

Here are a few places I recommend:

• AIG
• Zander Insurance Group
• Met Life

or you could buy it from your local insurance agent or financial advisor that you trust.

I told you this would be a topic that you didn’t want to read about! It’s okay. The only things certain in life are death and taxes. Face reality and prepare for the worst. You owe it to your family.

If you think your family needs a life insurance policy and are looking for ways to pay for it check out the marriage budgeting tips and coverage of joint bank accounts for married couples to help make a plan and work together towards it. 

This coverage of buying life insurance in marriage is part of the Marriage Money Guide.

A reader sent the following response to yesterday’s post on avoiding Social Security payments.  I asked them for permission to share it because the email reminded me that Social Security is a safety net for many people and asks some interesting questions about keeping the Social Security program viable:

Reader Response:

Why would your wife forfeit her Social Security contributions?  My wife taught for a year under the Missouri Educators’ Retirement System.  We converted her contributions and earnings to an IRA when we left the state. 

During her last six years as a teacher in South Dakota, and previous years teaching in Kansas and Iowa, she contributed to Social Security, as most public educators do.  Her annual Social Security update lists her record of contributions in these states and forecasts her benefits upon retirement, which I fully expect she will someday receive. 

Why would you have any more confidence in the survival of Missouri’s retirement system over Social Security?  Both can go bust.  One in fact might argue that a program that has been around since the late 1930s and has the backing of the Federal Treasury has a more secure future than a relatively new program from a midsized Midwestern state. 

It all comes down to political and public will.  Will we allow Social Security to fail or embrace obvious remedies toward solvency?  Why not raise the cap on payroll taxes past $96000 (maybe even tax investment income), consider raising the retirement age for full benefits, or demand politicians quit raiding the Social Security Trust Fund for other expenditures? 

For the past seventy years, Social Security has been an essential part of the safety net for millions of Americans, particularly among the lower and lower middle classes.  Its benefits not only help retirees, they assist disabled workers and their families as well as spouses and children of deceased bread winners. 

For example, my wife’s grandmother, a former housewife widowed in her mid-sixties, could not have survived into her mid-eighties without her survivor’s monthly Social Security check.  There are millions of more just like her today as there will be tomorrow. 

Frankly, the question shouldn’t be how do we avoid paying into Social Security but rather can we find the moral and political courage to protect this vital program for future generations.

What? Is that possible, to avoid Social Security payments?  Well, like most things in personal finance the answer is that it depends.

My wife didn’t pay one cent into Social Security for the last seven years of working, better yet, it was all legal and above board.  As a state employee, she still contributed to a mandatory state retirement plan but she was exempt from paying into Social Security.  Being a teacher does have some benefits : )

Teachers get the summers off and don’t have to pay Social Security, at least in our state anyways.  Of course they don’t get paid as well as people in the private sector but the benefits are nice.

One of the things I dislike about the Social Security money coming out of my paycheck is that I’ll likely never see any of it again.  When she was working she had the comfort of knowing that all the money she contributed would probably be there for her when we turn old and gray.  It’s as if the personal finance fairy came up to us and asked if we wanted to stop throwing money away every month and poof, it was done.

Of course, now that she’s not teaching and working a different part time job, any money she pays into Social Security will automatically be forfeit.  I haven’t researched it myself but according to other teachers if you draw from the state retirement plan, any money you did pay into Social Security before or after teaching is forfeit. This really hit one lady who worked in corporate America for 10 years before becoming a career teacher. All her Social Security contributions from that time were down the drain.

Anyhow, if you’d like to avoid paying into Social Security, just become a teacher!

Would that headline catch your eye on a piece of mail?  It’s a pleasant thought to be 18, footloose and fancy free again.  No big projects at work, no mortgage to worry about, and no sense of responsibility keeping you awake at night.  Plus to top it off you’re not even broke!

Back to Reality
As I opened the letter my thoughts of being young with money were rudely interrupted by a reminder that my next chance to shed these heavy burdens would likely come when I was old and grey.  Ameriprise Financial was inviting “me and my guests for an exclusive dining experience”, which also featured  “a private presentation of Retirement: Planning Beyond the Numbers”.

Exploring Retirement
The Ameriprise brochure notes the presentation will explore issues such as:

• Defining your dreams for retirement.
• Envisioning the life you hope to live in retirement.
• Retiring TO something rather than retiring FROM something.

I think it is a good idea to define your financial goals early on in life and retirement is definitely one of them. The brochure says everyone who attends the event will get a copy of the Dream Book guide to help with their retirement planning.  A free meal, free book, and a presentation about money do pique my interest but I haven’t called to sign up yet.

Our Ameriprise Financial Experience
When we decided to create our first official financial plan about 5 years ago we had an initial consultation with someone from Ameriprise Financial.  He was a nice guy but we decided to go a different route.  Our main complaint was that he had no financial experience!  He was fresh out of college with just a general Business Administration degree and he wanted to be our financial advisor.

There was a more experienced person sitting in on the consultation but the rookie would be the one creating our plan.  I know everyone has to learn somehow but I didn’t want him learning with our money.  We ended up hiring a fee only financial planner who was both a CFP and a CPA, and for a cheaper price than Ameriprise!

Retirement Seminar Conundrum
Despite our initial experience with Ameriprise I’m still debating whether or not to sign up for the retirement seminar. As I mentioned, it’s hard for a cheap guy like me to pass up a free seafood dinner at a nice restaurant.  I do enjoy hearing and learning about ways to invest money so it might be an interesting presentation despite the emphasis I imagine will be placed on Ameriprise products.  What do you think, worthwhile educational dinner or a waste of time?

If a wealthy retired corporate executive gave you retirement advice would be thankful or feel like they were rubbing your nose it in?

Executive Privilege
Our most recent company newsletter featured several former corporate executives that have retired from the business to pursue their life’s ambitions.  I had mixed feelings as I read the article in my worker-drone cubicle.  They all gave good advice on preparing for retirement but they also had much larger salaries than most people in the company.  I understand that the corporate benefits office was trying to promote 401k investing and good money management with the article but it didn’t sit quite right reading about these executives living their dreams while we slave away in our cubes.

Money Management
These executives worked long and hard to get to the top but they didn’t achieve early retirement simply by earning a lot of money.  They were smart and managed their money well.  The article started off by explaining they had all set their retirement goals when they were young and managed their lifestyles and finances around the goals.  It also mentioned that the booming market of the 1990’s had a part in helping them retire early.

Retirement Advice
Here are some of the actions and philosophies the executives follwed that allowed them to retire early:

– maximized participation in the company 401k, invested in non-company plans like a Roth IRA, and worked there long enough to become fully vested in the profit sharing plan

– lived a conservative life style, tried to manage their money to stay out of debt and that left more money to invest for retirement

– "When I got extra money it went into investments; I didn’t drive big fancy cars and I didn’t buy big fancy houses.  You have to put aside to take care of yourself, and if a company hands you money, you have to manage what they hand you"

– Started planning for retirement as soon as they joined the workforce, first thing they did was start a savings account

– Remained debt-free

– "It’s all about choices: if you choose to spend, you choose to work until you pass away; and if you choose to save, you leave when you want"

Article Reactions
I’m glad that our company is trying to promote planning and saving for retirement, I just wish they had used some role models that more of us workers could relate to.  I’m afraid that since only executives were interviewed people may miss some of the message on money management and focus on the fact they need to become corporate big shots to make enough money to retire.  What do you think?  Did the executives inspire our workforce to save?  Will people be able to see beyond the big salaries to the wise retirement preparaton advice?