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The Three Cs of Retirment Planning

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A reader asked the Financial Post in Yahoo News, “I’m set to retire later this year and my portfolio is down 30 percent. What should I be doing? I don’t know if I have enough money to retire anymore. — Cynthia. Columnist Julie Casein replies, “Cynthia, welcome to a bear market. I imagine things were going along just fine for you and then you were suddenly caught out. Now the question is: what to do?” Sadly, Cynthia is not alone. In fact, there are millions of retirees who will find themselves in a similar circumstance.

So what’s the typical advice for those on the cusp of retirement who suffer significant market losses near the finish line?

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  1. This world NEVER seems to lack for free advice. Such was the case with the first chronological book (as to most likely when written) in the Bible, Job about two hundred years before Moses wrote the Torah. The old adage seems more appropriate today than ever: “Ya gits what ya pays for.”

    I appreciate Shannon’s putting us all on notice that he does not consider himself a financial planner. It would be great if many more in the industry took that position.

    For example, in one webinar of a major lender not long ago, an attendee informed all of us that he had proven a particular strategy and by his way of writing, it was clear we were not among even the first that he declared this strategy “proven.” What made it obvious he did not know what he was talking about was his statement that what really made the strategy worthwhile were the income tax benefits from the deduction of the accrued interest. When the webinar leader correctly asked how he was so sure that interest accruing on HECM proceeds that were used to live on were deductible, the originator replied that it seemed they would be. The fact was he had “proven” nothing since such interest falls under the category of nondeductible personal interest.

    In another webinar of the same major HECM lender by a different and far more careless presenter, the presenter falsely claimed that reverse mortgage proceeds can reduce income taxes by replacing rental income proceeds with reverse mortgage proceeds. Unlike an IRA where taking cash from a taxable IRA will generally trigger taxable income, the mere payment by the renter creates taxable income for a cash basis landlord whether the landlord deposits the payment or not; for an accrual basis taxpayer, rental income is taxable in the year earned. In income tax lingo, cash basis taxpayers have income upon constructive (does not have to be actual) receipt of the income. Of course there are many other errors in the ideas presented by this so called financial expert.

    While many falsely claim that reverse mortgage proceeds are tax-free, they are tax-free only to the extent that other nonrecourse debt is tax-free. See IRC (Internal Revenue Code) Regulation Section 1.1001-2 [otherwise cited as 26 CFR 1.1001-2] and more importantly the US Supreme Court’s decision in Commissioner v. Tufts, 461 U.S. 300 (1983). Both of these citations can be accessed free online through a search on Google. To be clear it is NOT known if reverse mortgage proceeds will or will not result in at least some of those proceeds increasing income tax liability to the borrower until termination. This will never occur if the value of the collateral at termination is greater than the UPB at termination. It is only

    1) when the amount payable at termination is lower than the UPB at termination (the nonrecourse provision comes into play) or
    2) if a lender otherwise reduces the UPB by act of forgiveness

    that any portion of reverse mortgage proceeds may be subject to income tax; however, even then it is possible that any resulting increase in taxable income may not increase the federal or state income tax liability of the borrower. The determination is heavily weighted by the income tax facts and circumstances of the taxpayer in the tax year of termination. Yet both 1) the cited regulation and 2) the Tufts decision by the US Supreme Court demonstrate the possibility of such an event occurring. Normally the lender SHOULD issue a Form 1099-C when 1) the value of the collateral is LESS THAN the UPB of the reverse mortgage at termination or 2) the lender otherwise forgives any portion of the UPB. Such filing should indicate that the reverse mortgage is nonrecourse and the amount shown is the amount of debt deemed uncollectible as a result of the nonrecourse provision in the reverse mortgage loan documents.

    Also in the rare circumstance where a taxpayer was able to deduct interest on the accrual method of income tax accounting, some or all of the accrued but unpaid interest (and if applicable MIP) may have to be picked up as ordinary income in the tax year of termination. Such explanation is outside of the scope of this comment and as implied in the first paragraph, my advice on such matters is not free.


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