Some seniors who have most of their
equity in their home want the security of a fixed-payment annuity, and
don’t care about not leaving any equity behind for their heirs. A Home
Equity Conversion Mortgage or HECM, which is insured by FHA, can fund
the purchase of a fixed-payment annuity in two ways.
Tenure Versus Lifetime Annuities
One way is for the senior to exercise
the “tenure” option under the HECM program, and receive a fixed annuity
payment for as long as he remains in the house. The second way is for
him to exercise the credit line option under the HECM program, drawing
the maximum amount permitted, and use it to purchase an immediate
annuity from a life insurance company.
I shopped both options in early
December, 2009 for a male of 86 with a house worth $400,000. This senior
had a “Net Principal Limit” (NPL) under the HECM program of $288,000.
That is the maximum amount of cash available for purchase of either
annuity, after deducting HECM origination costs.
The NPL of $288,000 would purchase a
tenure annuity of $2444 within the HECM program. Alternatively, the
senior could draw the $288,000 in cash, maxing out the HECM, and use it
to purchase an annuity of $3778 from a life insurance company. This is
55% higher than the tenure annuity. (I found this quote on
www.immediateannuity.com.)
However, the two annuities are not completely comparable, and the
differences can be important.
Advantages of the Tenure Annuity
First, the HECM tenure annuity is
guaranteed by the Federal government. The life company annuity is only
as good as the promise of the insurance company, loosely backed by state
guarantee programs. While defaults on annuities are rare, I would not
purchase an annuity from a company that did not have an AA rating. The
quote above was from a AA-rated company.
A second important difference is that
the borrower who takes a HECM annuity retains ownership of the reserve
account underlying the annuity. This allows him to change his mind after
a few years and switch to a credit line for the reserve amount still
available. And if he dies soon after making that switch, the amount
remaining in the reserve will go to his estate.
In contrast, on a life company annuity,
early death terminates all payments unless the policy has a guaranteed
payout, which would reduce the annuity amount. For example, the lifetime
annuity could be purchased with a 10-year guaranty, so if the annuitant
dies early, the heirs would continue to receive the payment for 10
years. But this would reduce the annuity amount to $2467, which is
little more than the HECM tenure annuity.
Advantages of the Lifetime Annuity
On the other side of the ledger, if the
borrower gets sick and has to go to a nursing home, the HECM annuity
will terminate after a year of non-occupancy.
That’s why it is called a “tenure annuity” rather than a “life
annuity”. The lender takes the house after the year and sells it, with
any equity remaining going to the borrower’s estate. With a life company
annuity, in contrast, the senior could be in a nursing home forever
without shutting off the annuity.
In sum, the advantage of the HECM is
that it preserves the senior’s freedom of action and may preserve some
equity for heirs. The disadvantage is the lower annuity amount. The
senior who seeks the largest possible monthly payment, and has no regard
for how much equity passes to heirs, will purchase a life company
annuity.
I write this with some trepidation, however, because some serious abuses have arisen in connection with reverse mortgages that have been used to purchase life annuities. These abuses have to be avoided.
Avoiding Abuses Connected to Dual Transactions
Seniors can easily avoid the hazards by
following two simple rules. Rule number one is to keep the HECM
transaction and the annuity transaction separate. That allows you to
shop for both individually. Packaging two very different types of
transactions into one deal obscures the pricing of both.
If a loan provider or an insurance agent
talks to you about drawing funds from a HECM to purchase an annuity, run
like a thief. He is looking to make two commissions from you, and they
both are likely to be extortionate.
Rule number two is to do it yourself. It
turns out to be really easy to find the best available deal on a HECM,
and I’ll explain how to do it next week. Shopping on-line for a life
annuity is also very easy.
Doing it yourself means that you avoid being solicited. Seniors who are taken advantage of are almost always seniors who have been solicited by fast-talking scamsters. You refuse to be exploited by refusing to be solicited.