Pension plans should be integrated


Suppose automobiles are marketed as pension plans. Then the chassis, engine and tires would be marketed by different companies and the buyer would have to assemble them. Yes, that would be absurdly inefficient, yet that is exactly the case with pension plans. The three major components – financial asset management, annuities and HECM reverse mortgages – are marketed by different firms which, with a few exceptions, do not communicate with each other. The result is absurdly ineffective.

On top of that, the annuity and reverse mortgage markets are extremely inefficient, due to their complexity, the lack of sophistication of most buyers, and the lack of multiple transactions that buyers can learn from. In both markets, the range of prices on identical transactions is obscene.

The ineffectiveness of the piecemeal approach doesn’t matter much to retirees who are wealthy enough not to care. But it is of crucial importance to the larger and growing number whose home equity comprises a large portion of their wealth. This article describes the benefits that would accrue to this group from the combined integration of competitively priced annuities and reverse mortgages. It also indicates the challenges of successful integration and the regulatory barriers that discourage it.

The educational challenge

Developing retirement plans that integrate financial asset management, annuities and HECM reverse mortgages, each of which are riddled with complexities, for retirees who are past their intellectual peak poses a major educational challenge. Responding to this requires a “targeted education” strategy, which is consistent with best practices developed by the U.S. National Strategy for Financial Literacy 2020, but adds an additional feature.

The educational process involved in developing a retirement plan should be divided into two phases. Phase 1 would limit the amount and complexity of information required for a retiree to learn what a pension plan is, how the pieces fit together, and what a first approximation of her plan looks like.

In phase 2, the retiree, in consultation with a financial advisor, who has access to a wider range of data, converts the preliminary plan into a final plan. This plan takes into account additional features and options which reflect the preferences of the retiree, but which were excluded from the preliminary plan. This article largely focuses on phase 1.

Funds available based on integration versus autonomy

Take the example of a 64-year-old retiree who has financial assets of $ 500,000 and home equity of $ 400,000. The integration approach combines asset management, a 10-year deferred annuity and a HECM reverse mortgage line of credit. The prices of annuities and reverse mortgages are competitive market quotes. This is compared to a stand-alone approach based on the 4% rule which is widely used by financial advisers. The 4% rule involves withdrawals of 4% of the amount of the original asset portfolio increasing by 2% per year. To make it comparable to the integration case, we add a HECM seniority payment, which is a fixed monthly amount. Unlike the life annuity, the seniority payment ends if the borrower leaves home.

Figure 1 compares the funds available to the retiree using the two approaches, assuming a rate of return on assets of 4%. The integrated approach provides more usable funds throughout the retiree’s life and full protection against burnout due to too long a life. At a 4% rate of return, the 4% rule runs out at age 98, only the payment of the tenure remains. Higher rates of return will avoid calamities under the 4% rule but increase the benefit of integration. Note that the timelines in this chart and others assume that the funds available are growing by 2% per year.

Impact of competition on available funds

To assess the impact of competition on pension plans, we consulted the pricing networks of annuity providers and reverse mortgage lenders. In Chart 2, the top line is calculated at the best conditions in both markets, as was the case in Chart 1, and the bottom line uses the worst conditions in both markets. But note that even using the worst terms, integration beats the 4% rule.

HECM program rescue

The HECM program could be canceled by Congress due to large deficits in the mortgage insurance reserve fund that could require an injection of funds from the Treasury. The causes of the deficits are very clear. The existing stand-alone model resulted in an excessively large proportion of borrowers drawing maximum cash in the first year, leaving nothing to cushion the rise in taxes and insurance payments in subsequent years. The integrated model, on the other hand, includes a life annuity in all cases, and in most cases the annuity will increase over time. Foreclosures resulting from non-payment of taxes and insurance by borrowers in their later years will fall like a rock.

Phase 2: Converting a preliminary plan to a final plan

The role of the financial advisor in an integrated plan is to convert the preliminary plan chosen by the retiree into a final plan that takes into account additional features and options that were not included in the preliminary plan. The following list is illustrative:

  • The retiree may want to see how the plan is affected by the different rates of return on financial assets.
  • The retiree might want to include a death benefit in the annuity, which would reduce the amount of the annuity.
  • The retiree might want to create a “reserve” for the estate, with or without a provision that would make it available in an emergency.
  • The retiree might want to compare plans with and without HECM.
  • The retiree might want to see the plan with deduction amounts net of tax and / or including other sources of income that are not otherwise included.
  • The retiree might want a different future pattern of drawdown amounts rather than the 2% per annum rule assumed in the charts.

As for the last example, the retiree who plans to travel the world for several years before settling could opt for a plan that sees increases in funds available early on, followed by smaller withdrawals in subsequent years. Otherwise, the retiree may prefer to spend less the first years to have more later. These cases, illustrated in Figure 3, present these cases as modifications to the retiree’s preliminary plan.

Partial retirement

Consider the same retiree but with a difference. He is considering a 6-year partial retirement during which he will work part-time before taking full retirement. The purpose of partial retirement is to increase the amount of available funds that become available when moving into full retirement.

Using integration, a plan that would meet its needs is shown in Chart 4. Its financial assets are used to purchase a deferred annuity with a 6-year deferral period, so that annuity payments start at the start of the term. full retirement. This is the purple block of the graph. During the 6-year period of partial retirement, his available funds are made up of his employment income (the blue block) plus withdrawals from his HECM line of credit (the red block). However, only a small portion of the line of credit is used and when he retires the remaining balance in the line is used to purchase an additional immediate annuity, which is the green box.

The illustrated plan provides for a modest increase in the funds available during the period of partial retirement and a larger increase during the period of full retirement. Of course, every retiree is different and a plan should and can be tailored to suit individual circumstances.

Barriers to integration

Considering the substantial benefits of integration, it is reasonable to ask why this has not happened already? One of the main reasons has been the overbreadth of regulation. The HUD limits the ability of reverse mortgage lenders to participate in projects with other types of financial institutions, and they ask HECM advisers to warn borrowers of the dangers of annuities. HUD’s concern appears to be that reverse mortgage lenders and annuity providers collude to cheat retirees. While this is a well-justified concern, it should not apply to transactions based on competitive terms available on both annuities and HECMs.

State insurance agencies, in turn, fear that annuities funded by reverse mortgages could make insurers responsible for depleting annuitants’ estate values. However, retirees who use built-in plans that include HECMs make an informed decision that they want to convert their home equity into usable funds. Integration does not prevent them from setting aside funds for their estate, if that is what they wish. An outright ban on using a reverse mortgage to fund an annuity should not apply to integrated plans.

Resistance is also coming from the private sector. Many advisors who manage assets for clients are hostile to annuities, which reduce a retire’s financial assets on which the advisor’s fees are based. They argue that they may offer better returns than those obtained by insurers on funds provided by annuitants. This is probably the case most of the time because the investment policies of insurers are very conservative. The difference, which they ignore, is that insurers guarantee a specified return, but financial advisers do not.

Payments to an annuitant also include a mortality component, that is, payments not received by the deceased. Insurers are able to continue payments to retirees who live to age 105, as they can stop payments to those who die at age 65. This is what makes annuities unique and why they should be a central part of pension plans designed for retirees who are not wealthy. .


About Meredith Campagna

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