How Your Home Can Function as a Pension Plan for Your Retirement

Ah, the good old days of defined benefit pension plans. Pensions used to be common and a wonderful source of retirement income. But these benefits are increasingly rare. If you are feeling the stress of funding retirement, it is likely because you simply lack the guaranteed pension income that your parents probably had.  You have worked hard, but the structure of our financial systems changed and you may be feeling like you don’t have enough cash for retirement.

What is a pension and why was it so valuable?

A defined benefit plan is a type of pension in which an employer agrees to pay a specified monthly amount to the retired employee. Typically, this amount is predetermined using a formula based on the employee’s earnings history, age and tenure of service.

So someone with a pension likely had three significant sources of Retirement Insurance Company income: their pension payments, Social Security and personal savings.

How your home can be your own personal pension plan

For many people, housing wealth represents a sizable share of their overall net worth. But for retirees in particular, home equity is even more valuable.

Home equity represents more than 50 percent of net worth for the typical household over the age of 65, according to research published in the Journal of Personal Finance. As a percentage of wealth, housing commands 80 percent of total wealth for roughly 30 percent of people above the age of 62.

This is particularly good news for people who are struggling with how to pay for retirement.

If you own your home, you may be able to use your home equity to create a kind of pension for yourself.

How does reverse mortgage work as a pension replacement?

For homeowners age 62 and older, a reverse mortgage can enable you to access a portion of your home equity, which you can use to increase cash flow during retirement.

Unlike a traditional “forward” mortgage, monthly payments toward the loan balance are not required on a reverse mortgage. So rather than paying the lender each month, reverse borrowers is instead receiving funds from the lender.

The money received from a reverse mortgage is considered a loan advance, and as such, it is not subject to state or federal income taxes.  As you borrow from a reverse mortgage and receive portions of your home equity, the loan balances increases. The amount of funds borrowed must be repaid at some point. Repayment of the loan is not required until the borrower dies or otherwise vacates the home secured by the reverse mortgage loan.

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