Annuity+Interest only mortgage in Retirement
Annuity+Interest only mortgage in Retirement
Before he left the forum Hedgefundie was proselytizing the advantages of interestonly (IO) mortgages. He even claimed that one could find 30year fixed rate IO mortgages. Assuming that to be true and given today's low mortgage rates, I'm wondering if there is a subset of people that have an effective arbitrage opportunity with a Single Premium Immediate Annuity.*
Take this scenario:
65year old Male/Female couple. They can pay off mortgage or get a 30year fixed rate IO combined with an annuity. Since I don't know if these actually exist or how to find the rates, I'm going to take a wild guess and say the couple could get a 3.5% 30year fixed rate IO mortgage. This would take them to age 95 where if they were still in the house (unlikely) they could get a new mortgage that they would only need to service for a few years at most.
Home Value: $500,000
Home Equity: $100,000
$400,000 Fixed Rate IO @ 3.5% annual payments: $14000
Joint Life with 10years certain annuity with a $400,000 premium (for some reason this was a higher payout than simple Joint Life on Immediate Annuities, state Arkansas): $19,524
After reading Wade Pfau's book "Safety First" I know that the full value of a annuity payout isn't taxed. I don't really know how to figure out what part is taxable, so I'll show one example where the full payout is taxed at 15% and one where it's taxed at 0%.
Annuallytaxed
Annuity Payout: $19,524
Taxes: ($2928)
Mortgage: ($14,000)
Net: $2596
Annuallyno tax
Annuity Payout: $19,524
Mortgage: ($14,000)
Net: $5524
If the couple could actually get a mortgage as described above they would have successfully paired a nominal liability with a nominal income stream. Assuming the taxes are roughly accurate they would receive somewhere between $216$460 additional guaranteed a month without taking on virtually any more risk.**
I'm sure I'm missing a lot here, but I wanted to throw this out for comment by folks on the board smarter than me. Thanks
*folks more interested in a legacy obviously wouldn't benefit as much and neither would folks who wanted to use their home equity in the future for something else (like nursing home costs, etc.)
**conversely the couple could buy a annuity whose payout is exactly the same as the mortgage and invest/spend the difference
Take this scenario:
65year old Male/Female couple. They can pay off mortgage or get a 30year fixed rate IO combined with an annuity. Since I don't know if these actually exist or how to find the rates, I'm going to take a wild guess and say the couple could get a 3.5% 30year fixed rate IO mortgage. This would take them to age 95 where if they were still in the house (unlikely) they could get a new mortgage that they would only need to service for a few years at most.
Home Value: $500,000
Home Equity: $100,000
$400,000 Fixed Rate IO @ 3.5% annual payments: $14000
Joint Life with 10years certain annuity with a $400,000 premium (for some reason this was a higher payout than simple Joint Life on Immediate Annuities, state Arkansas): $19,524
After reading Wade Pfau's book "Safety First" I know that the full value of a annuity payout isn't taxed. I don't really know how to figure out what part is taxable, so I'll show one example where the full payout is taxed at 15% and one where it's taxed at 0%.
Annuallytaxed
Annuity Payout: $19,524
Taxes: ($2928)
Mortgage: ($14,000)
Net: $2596
Annuallyno tax
Annuity Payout: $19,524
Mortgage: ($14,000)
Net: $5524
If the couple could actually get a mortgage as described above they would have successfully paired a nominal liability with a nominal income stream. Assuming the taxes are roughly accurate they would receive somewhere between $216$460 additional guaranteed a month without taking on virtually any more risk.**
I'm sure I'm missing a lot here, but I wanted to throw this out for comment by folks on the board smarter than me. Thanks
*folks more interested in a legacy obviously wouldn't benefit as much and neither would folks who wanted to use their home equity in the future for something else (like nursing home costs, etc.)
**conversely the couple could buy a annuity whose payout is exactly the same as the mortgage and invest/spend the difference
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
Hedgefundie is in the accumulation stage and has enough assets to "play" with his portfolios.
30 years is a long time, $400,000 is a lot of money. No way I would give up control of that much of my portfolio for 2K 5K per year. You will not be interested in "arbitrage opportunities" in your late 80s.
Pay off the mortgage, it will feel a lot better. And the equity is there if you ever need it.
30 years is a long time, $400,000 is a lot of money. No way I would give up control of that much of my portfolio for 2K 5K per year. You will not be interested in "arbitrage opportunities" in your late 80s.
Pay off the mortgage, it will feel a lot better. And the equity is there if you ever need it.
Prediction is very difficult, especially about the future  Niels Bohr  To get the "risk premium", you really do have to take the risk  nisiprius

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Re: Annuity+Interest only mortgage in Retirement
This is an interesting idea but kind of feels like I would be trying too hard if I were to adopt it. Basically trading home equity for a higher income stream. My willingness to use it would probably depend on how much I felt I need the extra income each month. As David Jay said, you are giving up control of a lot of money.
Some comments:
Some comments:
 You are effectively spending 400k of home equity over the 30 years of this plan. The "juice" in this plan comes using this 400k to buy an annuity thus gaining the mortality credits on the annuity. Your first footnote mentions this this plan is not good if you want to leave a legacy or think you might need the cash.
 It is unlikely they will want to refinance at 95 but if they do, they may not have the income to afford/qualify for a new mortgage with the annuity gone. Especially if one of them is gone and SS/pension income is lower.
 Have you thought about comparing this to some kind of reverse mortgage? It seems like that might be a way around the forced "exit" at 95. I have no idea whether there are suitable reverse mortgage products available now.
 The annuity would carry some risk of default by the insurance company.
 If they are in a position to itemize, there could be tax advantages with the mortgage deductibility.
 As mentioned in the bullet points above, there is some risk in this plan the risk of outliving it and needing the home equity either to spend or renfinance and the insurance company risk. These are small but they are risks.
Last edited by IowaFarmBoy on Thu Aug 27, 2020 2:36 pm, edited 2 times in total.

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Re: Annuity+Interest only mortgage in Retirement
duplicate deleted
Re: Annuity+Interest only mortgage in Retirement
Could be, I honestly know diddlysquat about reverse mortgages. Might be to accomplish the same thing.IowaFarmBoy wrote: ↑Thu Aug 27, 2020 2:13 pm Have you thought about comparing this to some kind of reverse mortgage? It seems like that might be a way around the forced "exit" at 95. I have no idea whether there are suitable reverse mortgage products available now.
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
If you don't like that plan, and you could use tax free money for the annuity, you could use $287,000 to buy an annuity that pays out $14000 year and invest the remaining $113,000.
Using a 60/40 mix for 20 years (your 80s in your example) has historically gotten you somewhere between $348,000$1.08M (nominal)/$208,000$653,000 (real), going by the 10th and 90th percentiles in a Monte Carlo simulation in Portfolio Visualizer.
https://bit.ly/2EqAzpM
(for some reason each time I open the link the total returns numbers are slightly different, so my numbers above might be a tad off)
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
The trick may be in finding a mortgage they qualify for at a rate with that much differential with the annuity. Is the idea that the mortgage is interest only for full 30 years? So, then the estate would have to pay off the principal or they would when hitting 95? I think most interest only have a shorter time period when interest only & there is a prepayment penalty (which I guess the estate would have to pay if they die in less than 30 years). Don't know how you grabbed that rate, but does it assume only the best credit score? Several things unclear to me about the mechanics since I'm not familiar with these.
But real reason for posting was to say that I believe the taxation of the annuity is based on life expectancy, terms of annuity, etc. For example in your example, the "10 year certain" term would affect the amount taxed compared to not having the certainty period. Once past the life expectancy, it is all taxable. Taxable amounts are always "ordinary income". If their income is at a certain level and/or IRA distributions kick in, it could trigger, more social security being taxed, IRMAA, etc.
But real reason for posting was to say that I believe the taxation of the annuity is based on life expectancy, terms of annuity, etc. For example in your example, the "10 year certain" term would affect the amount taxed compared to not having the certainty period. Once past the life expectancy, it is all taxable. Taxable amounts are always "ordinary income". If their income is at a certain level and/or IRA distributions kick in, it could trigger, more social security being taxed, IRMAA, etc.
Re: Annuity+Interest only mortgage in Retirement
At the end, the annuity payments will come to an end, but you'll still owe $400,000 on the mortgage.
Re: Annuity+Interest only mortgage in Retirement
Assuming the couple is alive, why would the annuity payments come to an end? They are LIFE with 10 years CERTAIN. The mortgage would come do. Assuming you couldn't roll it (don't know why), you would have a few things going for you:
 You are still receiving the annuity
 30 years prior you still had $100,000 in equity. Given even modest inflation the home value should be more than enough to pay off the mortgage with room to spare
 You could take my second example I gave to David Jay. Buy an annuity for $287,000 that pays off the yearly interest (assuming no tax, like through a ROTH I suppose), and invest the remaining $113,000. Assuming you stay in the house (I assumed 20 years), in almost all historical cases you'll end up with more money than you would have with just paid off the mortgage. Now you have the annuity AND more money.
Last edited by ScubaHogg on Thu Aug 27, 2020 3:57 pm, edited 1 time in total.
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
 As I mentioned in the original post, a previous forum member (Hedgefundie) stated that these 30year fixed IO loans were available. I just went with him at his word, as it appears you have to call around to find them and I didn't want to do that. For the interest rate, I've seen traditional 30year mortgages being quoted at 2.5%, so I just added a full point to those. I literally have zero idea if that is reasonable or not, but it didn't seem exceptionally unreasonablenot4me wrote: ↑Thu Aug 27, 2020 3:41 pm I think most interest only have a shorter time period when interest only & there is a prepayment penalty (which I guess the estate would have to pay if they die in less than 30 years). Don't know how you grabbed that rate, but does it assume only the best credit score? Several things unclear to me about the mechanics since I'm not familiar with these.
Taxable amounts are always "ordinary income".
 As for taxes, what if you bought the annuity out of a ROTH?
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
I don't understand interest only mortgages  essentially you are just a renter. So why not just rent? Sure you can hope and pray that the house value increases in the 30 years but that is certainly not guaranteed.
Re: Annuity+Interest only mortgage in Retirement
I second that you should compare this vs a reverse mortgage.
Re: Annuity+Interest only mortgage in Retirement
Rents go up. Landlords/Management changes, sometimes you get kicked out, etc. While owning requires maintenance, you also get to choose whether to upgrade, paint, etc. Renting and owning each have their advantages.
Re: Annuity+Interest only mortgage in Retirement
Cause you would still have all the advantages of owning and avoid the disadvantages of renting. To quote Hedgefundie from a different thread:
The biggest one is with an IO mortgage your housing "payments" are fixed in stone for 30years (yes yes, maintenance and all that, but that still holds true if the mortgage is paid off). With rent it will almost certainly go up.HEDGEFUNDIE wrote: ↑Sat Feb 22, 2020 6:56 pm Renting has the following drawbacks:
1. The rent can go up
2. Your lease could be terminated by the owner
3. You can’t do much to the property to improve quality of life
An interestonly loan can have a fixed rate for up to 30 years, during which time you have certainty of expenses. You also participate in any home value appreciation (but of course this is a risk as well).
And to be clear, you don't need the home value to go up. Given the second option I outlined above, you could buy a $14,000/year annuity for ~$287K and invest the remaining $113K. Historically, after 20+ years you would have had more money AND the annuity in almost every case.
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
The two cash flows are not paired. If you assume the mortgage isn't "rolled over" after 30 years then,
If you assume the mortgage is rolled over at the same interest rate, they are still not paired. The annuity is an income stream that continues for a joint lifespan, but the interest only mortgage is a cash outflow that continues forever. And "forever" is longer than any lifespan.
The proper comparison is between the interest rate of the mortgage and the return (not the payout) of the annuity. Given your example of $400,000 buying $19,524 per year and assuming a 30year joint lifespan, this would be 2.7%.
2.7% = 12 * RATE(30 * 12, 19524 / 12, 400000, 0, 0) using the Excel RATE function
Yes, the taxation of a commercial annuity is based on life expectancy, but it isn't tax free until that time and fully taxable afterward. Rather a portion of the annuity is tax free every year. This is the "General Rule" as explained in IRS Publication 939:
where "expected return", as stated here in Pub 939, is... the taxfree part of each annuity payment based on the ratio of your investment in the contract to the total expected return.
A 10year period certain feature would increase the expected return, but I doubt by much.Joint and survivor annuities. If you have an annuity that pays you a periodic income for life and after your death provides an identical lifetime periodic income to your spouse (or some other person), you figure the expected return based on your combined life expectancies.
 Uncorrelated
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Re: Annuity+Interest only mortgage in Retirement
Interest only mortgages are a bad deal, unless:
There are considerable tax advantages, as is the case in my country.
you have liquidity issues.
If those don't apply do you, you are better off leveraging stocks using options of futures. An interest only mortgage is just an expensive form of leverage after all. I'm not sure how this works with annuities specifically, but holding both bondslike products and a mortgage is generally considered to be a very stupid idea unless the above criteria apply.
There are considerable tax advantages, as is the case in my country.
you have liquidity issues.
If those don't apply do you, you are better off leveraging stocks using options of futures. An interest only mortgage is just an expensive form of leverage after all. I'm not sure how this works with annuities specifically, but holding both bondslike products and a mortgage is generally considered to be a very stupid idea unless the above criteria apply.
Re: Annuity+Interest only mortgage in Retirement
I hadn't seen the need to be very specific in my previous post & didn't mean to imply that it was tax free before reaching life expectancy. I just mentioned there were variables "that would affect the amount taxed"  didn't realize some would think that meant NONE was taxed. As for after expectancy (or if joint, expectancies) passes, it may not be precise at that time, but I still believe that every year won't have a portion taxfree. Same IRS pub you cited also says: "However, if your annuity starting date is after 1986, the total amount of annuity income that is tax free over the years can't exceed your net cost."#Cruncher wrote: ↑Fri Aug 28, 2020 6:59 amYes, the taxation of a commercial annuity is based on life expectancy, but it isn't tax free until that time and fully taxable afterward. Rather a portion of the annuity is tax free every year. This is the "General Rule" as explained in IRS Publication 939:where "expected return", as stated here in Pub 939, is... the taxfree part of each annuity payment based on the ratio of your investment in the contract to the total expected return.Joint and survivor annuities. If you have an annuity that pays you a periodic income for life and after your death provides an identical lifetime periodic income to your spouse (or some other person), you figure the expected return based on your combined life expectancies.
Weeds getting too deep for me & unsure it matters in this specific; just trying to clarify for future readers...
Re: Annuity+Interest only mortgage in Retirement
I was wrong to read your post that way.
Thanks for pointing this out, not4me; I wasn't aware of it. The net result is that after the IRS designated life expectancy, all of the annuity will be taxable  as you say. Using the example in the original post:not4me in same post wrote:As for after expectancy ... I still believe that every year won't have a portion taxfree. Same IRS pub you cited also says [here]: "However, if your annuity starting date is after 1986, the total amount of annuity income that is tax free over the years can't exceed your net cost."
 The joint life expectancy of a man / woman couple both age 65 according to Table II in publication 939 is 22.0 years.
 The initial tax free portion each year would therefore be 0.931 [400000 / (19524 * 22.0)] of $19.524 or $18,177.
 Over the first 22 years the tax free portion would (ignoring rounding) equal the $400,000 cost (18177 * 22).
 Therefore after 22 years none of the annuity would be tax free.
Re: Annuity+Interest only mortgage in Retirement
Yeah, but the question is, do you care? After your joint lifetime ends, what difference does it make to you if the mortgage still has to be serviced?
Last edited by ScubaHogg on Fri Aug 28, 2020 2:13 pm, edited 1 time in total.
“Unexpected Returns dominate the Expected Returns”  Ken French
Re: Annuity+Interest only mortgage in Retirement
What liquidity issues would you have? Especially taking the second example I gave way above where you annuitize just enough to make the $14k/year interest payments, a couple could put the remainder (~$113k) back into equities. This would almost certainly increase, not decrease, their liquidity. All while still but guaranteeing they can make house payments.*Uncorrelated wrote: ↑Fri Aug 28, 2020 7:14 am Interest only mortgages are a bad deal, unless:
There are considerable tax advantages, as is the case in my country.
you have liquidity issues.
If those don't apply do you, you are better off leveraging stocks using options of futures. An interest only mortgage is just an expensive form of leverage after all. I'm not sure how this works with annuities specifically, but holding both bondslike products and a mortgage is generally considered to be a very stupid idea unless the above criteria apply.
The rate might be relatively expensive, but it is locked for decades and basically no more work is required. As for options and futures, not a lot of folks are capable of doing that in their prime, much less in their 80s. If it appealed to them, a very average couple (in terms of financial sophistication) could follow this plan.
*those numbers assumed that annuity payments weren’t taxed at all. I assume that would be the case if you used ROTH funds, but I don’t know. I also don’t know how wise it would be to use ROTH funds like this, but I’m just exploring the options.
“Unexpected Returns dominate the Expected Returns”  Ken French
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Re: Annuity+Interest only mortgage in Retirement
If you don't have any liquidity issues, it is fairly obvious that paying off the mortgage results in higher expected utility. A mortgage is used when you need leverage and other cheaper instruments (futures, options) aren't available. Or if you need money for food and all your net worth is locked inside your house. The latter seems to be the case in your example.ScubaHogg wrote: ↑Fri Aug 28, 2020 2:13 pmWhat liquidity issues would you have?Uncorrelated wrote: ↑Fri Aug 28, 2020 7:14 am Interest only mortgages are a bad deal, unless:
There are considerable tax advantages, as is the case in my country.
you have liquidity issues.
If those don't apply do you, you are better off leveraging stocks using options of futures. An interest only mortgage is just an expensive form of leverage after all. I'm not sure how this works with annuities specifically, but holding both bondslike products and a mortgage is generally considered to be a very stupid idea unless the above criteria apply.
Obviously this liquidity is expensive. The insurance company takes a cut of the annuity, and the mortgage broker takes a cut of the interest rate. If I did my math right (say 0.5% annually for a very cheap annuity, 2.2% above the riskfree rate for a very cheap 30y mortgage in my area) that accounts to approximately 2.7% expenses annually. That sounds terrible... But I suppose if you're in a tight spot, and have no bequest motives, it does help to free some liquidity.
It appears as if annuitizing in parts results in higher expected utility. The annuity payout becomes higher and higher as you get older. You could say the optimal strategy is to annuitize "just in time". This may increase the risk because the mortgage company might be unwilling to refinance the property multiple times over.
You mentioned earlier that you can put the remainder in equities. At an expected (excess) return of 5% for the stock market and guaranteed return of 2.7% for paying off the mortgage, it's probably a better idea to pay off the mortgage instead or use that money to delay annuitization. I say probably because the math is quite complicated. Some sources suggest that between age 72 and 81 all stocks should be exchanges for annuities (link to paper). Owning an expensive mortgage probably means annuitization should be done sooner, but I'm not sure.