News Analysis
BusinessWeek.com
September 27, 2006
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Don't Let Housing Haunt Your Retirement

With home-lending debt stretching further into the "golden years," older Americans may need extra income. Here are ways to counteract the crunch

Nowadays the old American dream of owning your own home outright can seem like just that: a dream. For reasons good and bad, Americans are increasingly carrying mortgage debt later in life. Retirees or soon-to-be retirees who haven't factored these mortgage payments into their retirement plans could need to come up with some extra income.

Meanwhile, the cooling housing market may be leaving many Americans with less home equity. Prices of existing houses fell in August for the first time in 11 years, the National Association of Realtors said on Sept. 25. Homebuilders like Beazer Homes (BZH ), KB Home (KBH ), and Lennar (LEN ) are also feeling the hurt (see BusinessWeek.com, 9/8/06, "Builders Brace for a Housing Downturn").

About a quarter of U.S. census respondents aged 70 and older reported having a mortgage in 2000, up from 19.9% in 1980. The number of census respondents in their 60s with a mortgage rose to 44.6%, from 34% two decades earlier. This mounting debt load "may suggest that the traditional rules of thumb for determining appropriate levels of retirement income are outdated," according to a recent report by the Financial Planning Assn.

OFFSETTING THE SHORTFALL.  In other words, many Americans may need even more money than they had planned on for retirement. The average 401(k) balance at yearend 2005 was $58,328, according to a study released last month by the Employee Benefit Research Institute and the Investment Company Institute. "There is a looming shortage on the retiree balance sheet that needs addressing, and it is spelled I-N-C-O-M-E," says David Rosenberg, North American economist at Merrill Lynch, in a Sept. 18 report.

The old retirement nest egg isn't what it used to be. While there's no easy solution, this week's Five for the Money looks at ways investors can bolster their retirement income to make up the mortgage gap.

1. Plan ahead
First of all, investors shouldn't necessarily be in a hurry to pay off their entire mortgage, so long as it has a fixed interest rate. "Being debt-free is an inherited ideal from older generations," says John Scherer, principal of Madison (Wis.)-based Trinity Financial Planning and a member of the Alliance of Cambridge Advisors. "That ideal, good in most respects, is misplaced in the context of an appreciating asset such as one's home."

Staying in debt may not sound appealing, but it makes financial sense. Historical returns suggest investors will get more from their money by investing it rather than using it to pay off their mortgage in a lump sum, financial advisers say. The actual cost of mortgage payments should decrease with inflation, and mortgage interest may also qualify homeowners for tax benefits.

However, retirees shouldn't carry a mortgage that will exceed more than 15% to 25% of their overall retirement income, notes South Riding (Va.)-based financial planner Phil Bour. It's also important that investors develop a plan for their retirement spending and build their mortgage payments into that plan to ensure they're living within their means.

"Some have suitable resources to carry a reasonable mortgage in a way that has advantages during retirement," says J. David Lewis, president of Knoxville (Tenn.)-based financial planning firm Resource Advisory Services. "Others do not. It is the appropriate balance that makes the difference."

2. Consider downsizing
Tough decisions could be in order. If investors haven't saved enough to sustain their expected spending during retirement, they might just have to sell the family homestead and buy something more affordable. After all, a smaller mortgage can mean smaller mortgage payments.

In some cases, retirees and soon-to-be retirees may want to talk with their children about other possibilities. Potential heirs might decide to help subsidize costs in the short run to inherit the property later, says Jenny Angel, a financial planner with Norcross (Ga.)-based Sanders Financial Management.

A reverse mortgage could be another option. Under this arrangement, homeowners can borrow against the value of their houses and receive a monthly check from a mortgage lender to boost their income (see BusinessWeek.com, 5/1/06, "Buy the Nest, Keep the Egg"). However, a reverse mortgage can have high fees, and if the homeowner's heirs can't repay the debt, they might lose the house.

3. Put your money to work
Retirees looking for extra money to meet their expenses may want to allocate a greater portion of their assets to income-oriented investments. More income tends to carry with it more risk, so the right investment option will depend on an investor's risk tolerance, notes Matthew Paladini, president of Irving (Tex.)-based Paladini Financial Management. He points to bonds, high-dividend real estate investment trusts, and large-cap stocks.

A "laddered" bond portfolio can also make sense for investors seeking income, adds Stacy Francis, president of New York-based Francis Financial. This strategy involves buying short-term bonds that mature in one, two, three, four, and five years, then reinvesting the proceeds in the five-year bonds as each group matures.

Immediate annuities are another option, suggests George Middleton, a financial planner with Vancouver (Wash.)-based Limoges Investment Management. An immediate annuity is a contract with an insurance company where a lump sum is paid up front in exchange for a monthly income stream (see BusinessWeek.com, 7/25/05, "Insuring Your Income").

4. Stay diversified
Older workers may find the risk of more aggressive investments just isn't worth it. In fact, retirees and soon-to-be retirees should typically maintain a more conservative asset allocation, because they are relying on their investment returns to cover basic living expenses. "It's a Catch-22," says Annette Simon, a financial planner with Bethesda (Md.)-based Mosaic Wealth Management.

From an investment perspective, it's important for older Americans to remain broadly diversified, whether or not they're making mortgage payments, financial advisers say. One fairly aggressive approach is cited by Sean Sebold, president of Naperville (Ill.)-based Sebold Capital Management: "We would recommend that clients put their money into a portfolio that is made up of at least 50% large-cap domestic stocks, 25% small-cap stocks, 15% international, and the balance in short-term bonds." Sebold says this allocation "keeps a moderate volatility in the portfolio, but a portfolio that is designed to beat the cost of a mortgage over a 7-10 year time horizon."

5. Revisit the labor market
Unfortunately, scrimping and prudent investment can only go so far. Many people will have only one realistic route to additional retirement income: earning it the old-fashioned way. About 77% of today's workers expect to work for pay even after they retire, according to a survey released on Sept. 21 by the Pew Research Center.

Workers who haven't yet reached their full retirement age for Social Security can earn up to $12,480 in 2006 without a loss in their Social Security benefits. A growing economy should provide plenty of openings for older workers, financial planners say. "The good news is that retirees will probably be able to find remunerative, challenging work well into their 70s," says Susan Fulton, principal at Bethesda (Md.)-based financial planning firm WealthTrust FBB.

Of course, not everyone will be able to stick with their current employer, particularly as companies look to cut costs. "You are starting to see things like couples who go out and drive a truck for a living," says Eve Kaplan, a Berkeley Heights (N.J.)-based financial planner. "It's a small number of people, but I think it's just going to snowball."

With no magic cure for the retirement crunch, Americans may need to change not their investment strategies, but their expectations. The first step to restoring the golden years' luster might be recognizing the problem that mortgage debt can pose during those years.