Do Reverse Mortgages Wipe Out All The Inheritance?

I recently read an article discussing whether reverse mortgages eliminate all the equity that the heirs might receive. A tax lawyer and reverse mortgage researcher believes it is not only the equity that should be considered but also the accrued interest paid on the reverse mortgage. Mr. Barry H. Sacks, JD, PhD, a practicing tax attorney described in a NRMLA conference in San Francisco, that the interest deduction can be used by the heirs to decrease the tax on say a 401(k) account. Sacks detailed how reverse mortgages accrue interest over the life of the loan but are not deductible until they are actually paid. He suggests that under the conventional approach to estate planning, where the estate sells the home and distributes the proceeds among the heirs and beneficiaries the interest deduction is lost. Sacks says, “this deduction would be lost in the conventional way that estate planning is done, but it can be recovered if the deduction can go to those children so they will get not only a great big 401(k) account left over from their parent, whose account has been enhanced by the judicious use of a reverse mortgage credit line, but they will also get that money tax-free – or at least a portion of it to the extent of the deduction.” Research shows retirees have 3 objectives – cash flow sustainability, a financial cushion for an emergency, and the ability to pass assets to their children. Sacks uses a reverse mortgage purchase to show how this works. Let’s say you are 62 or older and want to down size to a smaller home. You sell your current home for a million dollars and pay off the existing $300,000 mortgage leaving you with roughly $700,000 in sale proceeds. You want to downsize to a $750,000 home. You also have $500,000 in assets. You can buy the new home using the $700,000 sale proceeds and $50,000 from the assets leaving you with no mortgage payment and $450,000 in assets. Or you could buy the same $750,000 home by using $350,000 of the sale proceeds as a down payment and get a $300,000 reverse mortgage leaving you with no mortgage payment and the $500,000 in assets plus $300,000 from the balance of the sales proceeds for a total of $800,000 in assets. The interest on a $300,000 mortgage builds up over the years. “That’s a lot of interest and that could be deductible,” says Sacks. He continues, “Instead of the estate selling the house and paying off the reverse mortgage, the proper estate planning to achieve this result is to have the heir and beneficiary of the assets get the house directly, then sell it, because that’s the person who gets the deduction under the regulation.” So the common complaint that a reverse mortgage eats away their inheritance is wrong as Sacks contends, “the adult children are dead wrong because by taking a reverse mortgage and using it strategically, the parents are actually enhancing their heirs’ inheritance. They’re boosting – and by a lot – the overall value of their securities portfolio. Moreover, by thoughtfully planning or administering the estate, these heirs are going to get some, or all, of the securities portfolio free of income tax. It’s a pretty good result, especially if you’re a tax lawyer.” As always you should consult your financial advisors when doing any financial planning.

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