Differences Between Tenure Payments and Income Annuities
When comparing different strategies for coordinating home equity with portfolio distributions to generate retirement income, the tenure option fares well. As a way to fund retirement efficiency improvements, using the tenure-payment option from the line of credit as an alternative to purchasing an income annuity is worth exploring further. The tenure option “annuitizes” home equity as an alternative to annuitizing financial assets. If you are considering income annuities as you approach retirement, what could be a more effective way to build an income stream: purchasing an income annuity, or using a tenure-payment option on a reverse mortgage? The tenure option behaves similarly to an income annuity, though they are not the same.
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First, to be clear, a tenure payment does not necessarily provide a guaranteed monthly cash flow for life as an income annuity would. Guaranteed cash flow continues only as long as the borrower remains eligible for the loan by staying in the home and meeting homeowner obligations. Moving away from the home for more than a year would end the payments. While an eligible nonborrowing spouse may remain in the home if the borrower is no longer eligible, tenure payments stop once the borrower has become ineligible. Only when both spouses are eligible borrowers would the tenure payment behave like a joint-life annuity.
Another important difference is that no lump-sum payment (other than the up-front reverse-mortgage costs) must be given up from the investment portfolio to initiate the tenure payments. Each tenure payment is taken from the line of credit and moved to the loan balance as it is received. In the event that the retiree dies early, the loan balance may be substantially less than an annuity premium would have been. Conceptually, the tenure payment behaves more closely to an income annuity with a cash-refund provision, in terms of whether any assets are available at the end of the contract period. Still, there is no up-front, lump-sum premium to initiate these payments with the tenure option. This is an important distinction that allows the tenure payment to further preserve investment assets.
The tenure payment also does not provide mortality credits in a conventional sense. Mortality credits are part of an income-annuity payment; they are the subsidies paid by the short-lived in the risk pool to the long-lived. Tenure-payment pricing is based on an assumption that the borrower or borrowers live to age one hundred. Despite the lack of traditional mortality credits, tenure payments provide a degree of longevity protection, assuming the borrower remains eligible. Cash flow received from the line of credit through the tenure payment can exceed the value of the principal limit and can even exceed the value of the home. As I’ve noted, once this happens, the nonrecourse aspects of the loan provide spending power without a trade-off to legacy in a way philosophically similar to how an income annuity can continue to provide payments to the long-lived that well exceed the premium amount and interest. That nonrecourse aspect could be interpreted as a type of “mortality credit.”
A final difference is between the formulas that calculate tenure payments and income-annuity payments. As discussed before, the tenure payout rate depends on the ten-year LIBOR swap rate plus a lender’s margin and a mortgage-insurance premium rate of 0.5 percent. It also depends on an assumed time horizon or “life expectancy” of age one hundred. It does not vary by gender or whether payments are for one or two eligible borrowers.
Meanwhile, an income annuity depends on actual mortality data for the age and gender of the individual or couple, as well as on a lower interest rate that may be a bit higher than a ten-year LIBOR swap rate because of its link to corporate bond yields, but it doesn’t include a lender’s margin or mortgage-insurance premium in its calculation.
This is an excerpt from Wade Pfau’s book, Reverse Mortgages: How to Use Reverse Mortgages to Secure Your Retirement (The Retirement Researcher’s Guide Series), available now on Amazon.