Reverse mortgages in an estate plan: 7 pros and cons.
Before he passed away earlier this month, Fred Thompson had been a U.S. senator and a star of Law & Order, but he may have been best known by the end of his life as a pitchman for reverse mortgages on TV commercials. To some people, reverse mortgages have a bit of a low-rent feel to them, but even for some wealthier clients, they may make sense as part of an estate plan.
The basics of a reverse mortgage are that the lender issues a monthly payment based on the value of the home to the borrower, and the lender takes possession of the home upon the borrower's death. By law, the borrower must be at least age 62, so there's no clever way to guarantee payments for 50 years.
Clients who may be subject to the estate tax probably have enough assets that they don't feel the need to use a reverse mortgage, which pays the homeowner a monthly fee in exchange for ownership of the house after the owner passes. Nevertheless, it is true that a reverse mortgage reduces the value of that property, thus reducing the value of the estate, so if there aren't any heirs who want the house, it can make financial sense.
That alone may be enough to make some of your clients want to consider a reverse mortgage. Here are some of the positives and negatives they need to keep in mind:
Unless it's a family homestead, most primary homes will be sold after the death of the homeowner. Given that it's a forced sale, irrespective of the quality of the market in the neighborhood or city, it can often be an unfavorable sale, without a chance to maximize the sale price. A reverse mortgage can lock in a value that the owner is satisfied with. And the technique saves heirs the hassle of having to dispose of the property.
As mentioned above, the value of the home is transferred to the borrower, reducing the value of the assets left in the state. Upon the sale of the property, any equity over the reverse mortgage loan amount will revert to heirs, rendering the equity also subject to estate taxes.
Even if the clients don't face estate taxes, heirs may have to deal with capital gains and other taxes on the proceeds from the sale of the home. None of that applies with a reverse mortgage. In fact, the client can gift the payments from the reverse mortgage to the heirs to pay off their legacy early.
Alternatively, the proceeds from a reverse mortgage can be used to purchase life insurance. Upshot: The tax-free income stream generated by a reverse mortgage can be converted into larger death benefits for the client's beneficiaries. And if the life insurance policy is structured such that it pays the benefit to heirs, that money comes in tax-free dollars.
Some possessors of reverse mortgages are sometimes still eligible for the mortgage-interest deduction on the borrower's taxes. The accrued interest in the reverse mortgage may be available as a tax deduction upon repayment of the loan.
Clients should be prepared to stay in the house. The borrower has to repay the loan when they move out of the house, for whatever reason. Repayment on a reverse mortgage is triggered upon the death of the borrower/client, but also upon such events as the client entering an assisted living or long-term care facility. That could result in the client having to start repaying the reverse mortgage--at a point when the owner likely doesn't have much income.
A reverse mortgage is not available to vacation or other second homes. The reverse mortgage is only available for a primary residence, and if the borrower doesn't live most of the time in the residence, that triggers payments on the loan. The borrower is considered "moved out" if he or she hasn't lived in the home for a year.
So there are some valuable tactics available for clients who have considered a reverse mortgage. If some of your clients are in a position to take advantage of one, it can be a proactive move to suggest one, with the benefits and drawbacks ready to lay out. After all, they can no longer get this advice from Fred Thompson.
Read also these features by Tom Nawrocki: The new IRS rules on estate closing letters 529 plans vs. life insurance: 7 questions to ask clients When foreign wills become a problem
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|Publication:||National Underwriter Life & Health Breaking News|
|Date:||Dec 7, 2015|
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