The baby boom generation is nearing retirement and it is clear that millions of aging boomers are financially under prepared. Reasons are many - poor savings habits, rising medical costs, the demise of guaranteed corporate pensions, and the dreaded squeeze faced by many boomers: i.e. having to pay college costs for their children, care for their elderly parents, and save for retirement, all at the same time.
The outlook is not entirely bleak, however. One bright spot that may help baby-boomers achieve secure a retirement is the record high-level of home ownership and the related growth in home equity. Home equity, the difference between debt owed on a home loan and the value of a home, accounts for at least fifty percent of net wealth for more than half of all U.S. households according to the Survey of Consumer Finance. In much of the country, low interest rates have spurred refinancings and kept housing markets strong, both factors in boosting home equity growth.
Unfortunately, too many homeowners tap into home equity savings through cash-out refinancings, second-mortgage home equity loans, or home equity lines of credit (HELOCs) to pay for vacations, new cars, and other current consumption expenses producing no long-term wealth appreciation. These homeowners may be seriously eroding their ability to finance retirement. By cashing out home equity now, they are spending what has been a vital cushion in old age for past generations.
Homeowners who manage their home equity prudently, on the other hand, will enter retirement years with a substantial nest-egg to complement their other retirement savings accounts. This article describes seven specific ways in which the home equity nest-egg can be used to enhance retirement income planning.
Reverse Mortgage - Retirees remaining in their homes can still tap their home equity as a source of retirement income. Indeed, an entire industry has grown up around the reverse mortgage concept which allows seniors over 62 to tap into their home's value without making any repayments during their lifetime. A reverse mortgage (also known as a HECM - Home Equity Conversion Mortgage) requires no monthly payment. The payment stream is "reversed": instead of making monthly payments to a lender, a lender makes payments to you, typically for the remainder of your life, if you continue to reside in the home.
Some people try to avoid the fees typically associated with reverse mortgages and instead borrow against their home equity for retirement living expenses with a regular home equity loan or home equity line of credit (HELOC). Unfortunately this is seldom a smart strategy. The reason is that with either a conventional home equity loan or a HELOC loan, you have to make regular monthly payments that invariably will be at a higher interest rate than can be earned on the loan proceeds without undue risk. Moreover, as you use loan proceeds to pay routine living expenses, you risk running out of money. A HECM, on the other hand, provides income for the rest of your life.
There are many pros and cons to reverse mortgages and a complete discussion is beyond the scope of this article. Suffice it to say that the reverse mortgage strategy can be a sound one for many retirees. As with any major financial decision, it is essential that you seek qualified advice before committing to any particular HECM deal.
Take Advantage of IRS "Catch-Up" Rules - Congress created "catch-up" provisions to give older workers nearing retirement an additional tool to bolster retirement savings. In a nutshell, catch-up provisions for the various tax-advantaged retirement programs (i.e. IRA, 401k, 403b, 457, etc.) permit workers to make supplemental ("catch-up") contributions starting in the year the worker turns age 50. The amount of allowable annual catch-up varies by the type of retirement program and is summarized in this table.
If, for example, you are 55 and plan to sell your house when you retire at 62, it may be worthwhile to borrow on your HELOC today to catch-up on funding your retirement account. HELOCs generally allow for interest-only payments for several years meaning you will have to pay relatively low, tax-deductible interest until the house is sold and you are able to pay the principal balance. Again, with this strategy, you transfer funds from one savings category (home equity) to another savings category (tax-advantaged retirement account) to gain the advantage of higher-yield retirement account investments compounded for a longer period.
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Article Submitted On: September 02, 2005
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