Everyone has heard about diversification of investment, but very few advisors talk about diversification of income distribution in retirement. Taxes are usually the largest single threat to our retirement nest egg—especially for those who are wealthy. Yet most people just look at their “number” and forget how much has been pledged to the IRS from their IRA! It is important that we understand the role that reverse mortgages can play in this critical part of retirement income distribution. People in this industry are tired of hearing that reverse mortgages are just for the poor and those who have mismanaged their money or poorly planned for retirement. We know that a HECM is far more versatile. There are clear advantages to getting a reverse mortgage when you don’t need one.

It is easy for high-income, high-asset folks to make costly tax mistakes, and unfortunately, many financial advisors have narrow, orthodox views of retirement money management, which can limit people’s options.

As reverse mortgage professionals, the more we know about a variety of retirement products, the more valuable we are to our clients. Income taxation is a huge issue in retirement and often ignored until a big check needs to be written to the IRS because a large withdrawal is made on a retirement account.

So, what is the deal with taxes in retirement? In his book The Power of Zero, David McKnight does a great job of explaining the value of having money in non-taxable accounts for flexibility of withdrawals in retirement. He argues that it is not only how much we have in retirement funds, but also how much we can actually use. For example, a married couple has $40,000 in monthly income—including pensions and Social Security—and has another $40,000 coming out of IRAs. If they want to pull out another $30,000 to buy a car or remodel, they will likely be pushed into a 30 percent-plus tax bracket for the last distribution. So that $30,000 car really cost the client $42,000, not $30,000, because they have to take enough out of the IRA to pay the taxes. They may not even realize that they can be taxed up to 85 percent, even on their Social Security income.

There are lots of rules that apply to seniors in retirement, from increased standard deductions to required minimum distributions. The IRS is involved heavily in retirement accounts because it gave you a tax break when you put the money in many years ago—and you were told that you would be in a lower tax bracket when you retired. Seniors who properly saved and have a half million or more in IRAs or 401(k)s likely will not be in a lower tax bracket.

For example, I recently worked with a client with a multimillion-dollar IRA who had required minimum distributions of more than $150,000 per year—not even counting his other income. He is not in a lower tax bracket.

So, what does a reverse mortgage have to do with all of these rules? Many high-income individuals want to continue to have a mortgage so they have some deductions to reduce their taxable income. In fact, this is often an objection from potential clients. They have lost all of their other deductions—no dependent children, no college costs, no business expenses. They don’t want to pay off their mortgage because they still want (or need) the tax deduction; it’s all they have left. The sad thing is that a forward mortgage is very rigid and payments must be made every month no matter what. So let’s look at a perfect example of when a reverse mortgage can help from a deduction standpoint when a traditional mortgage could not. A client only has a $200,000 mortgage at a 4 percent interest rate. The mortgage interest is only $8,000 per year and will probably not be enough to itemize for a married couple because they would be better off using the standard deduction. So the interest deduction is worthless to them in further reducing their income. But if that same balance was on a reverse mortgage, they would not have to make payments for two or three or even four years, and then they would make one big payment of $20,000 or $30,000 in accrued interest and MIP (if applicable). Then, they would get a 1098 to use for that year and take full advantage of the deduction because it would exceed the standard deduction. Try that with a traditional forward mortgage! Don’t forget that no monthly mortgage payments were made, so no cash flow had to be taken out of the nest egg to potentially cause an increase in the tax bill.

But wait, it gets better! If your client has an ARM loan, it is a line of credit that continually expands to either make room for interest or additional borrowing power. So, when the client makes a $30,000 payment, which is applied first to interest and MIP, the credit line increases by about the same amount the very next statement. So, if the client pulled out $30,000 from the IRA to make the interest payment, now they can pull that same $30,000 from their line of credit and get the cash back—tax free!

In another example researched by Harold Evensky and John Salter at Texas Tech University and published in the Journal of Financial Planning, a client has no mortgage whatsoever and no real need for addition cash flow. So they simply take out a line of credit at 62. They then have control over how much non-taxable income can be taken out each year to reduce the amount of money they need from other taxable sources of retirement income, including the ability to delay Social Security income. One of my clients ended up saving more than $20,000 per year in taxes by making this simple change in the distribution of their retirement income.

Of course, your client must seek the advice of a tax professional and be aware that every situation is different. But, it is up to you to educate the client and the advisors you deal with about the tax implications and flexibility of a reverse mortgage compared with a forward mortgage. I often tell my clients that they have paid monthly mortgage payments for all those earning years and now they are old enough to decide when they want to pay. Maybe they want to pay their mortgage interest monthly, annually or after they die. When they want to make payments is up to them, not the mortgage company.

But the bottom line for your wealthy, high-income clients is that they need to be aware that a reverse mortgage can be a valuable cash management tool as well as a potential tax savings vehicle. Those who say that the reverse mortgage is a product of last resort just don’t understand the power of this very unique tool!