Can a reverse mortgage be used in estate planning?

Unexpected expenses can arise in retirement. An unexpected illness may require long-term care or other unexpected expenses. How can one plan for the unexpected, yet leave a bequest to heirs?

Before the housing crisis, some older Americans facing this issue took out reverse mortgages in order to channel a lump sum loan distribution into a financial product.

A reverse mortgage is a type of loan available to property owners who are age 62 or older. Unlike a traditional mortgage, the borrower does not pay interest during his or her lifetime as long as he or she continues to use the property as a principal residence.

When the individual passes or his or her home is sold or no longer used as a primary residence, the cash, interest, and other finance charges must be repaid.  All proceeds beyond the amount owed belong to the individual’s surviving spouse or estate.  This means any remaining equity can be transferred to heirs.  

The equity in a reverse mortgage could be paid out in a lump sum. Although such distributions could be used to fund a retirement account or assets in a trust, an attorney that focuses on estate planning might caution against risky securities or investments.

For example, time is certainly an important aspect in choosing between different retirement financial products. Many employers offer a Roth 401(k) as an alternative to a traditional 401(k). Choosing between them might hinge on an individual’s remaining work years. 

Said another way, the analysis may depend on whether the tax savings would be better if paid now or later. Those with many income-earning years ahead of them may benefit more from the interest-free appreciation in a Roth IRA or Roth 401(k) plan, where the contributions are taxable up front but then grow tax-free. Those closer to retirement may want the immediate tax advantage of a traditional IRA or 401(k) funded with pretax earnings.

An attorney that focuses on estate planning can help individual choose between all of the options that may be available. 

Source: The New York Times, “Parents, the Children Will Be Fine. Spend Their Inheritance Now,” Ron Lieber, Sept. 19, 2014

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