Optimal Retirement Asset Decumulation Strategies: The Impact of Housing Wealth

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Housing forms the majority of the non-pension wealth of most retired households. As well as providing a place to live, the house is also a store of value available for consumption.

The homeowner cannot simply pocket the full amount as he will need to use a portion of the proceeds to either rent or buy another place to live. Reverse mortgages enable the household to consume an amount that approximates the reversionary interest – the present value of the eventual proceeds – while continuing to live in the house.

We consider at what age and in what form the household should consume the reversionary interest, and the impact of the reversionary interest on the optimal allocation of financial wealth. Our strategy is to use VARs to estimate the relationship between the returns on the reversionary interest and financial assets, and use simulation techniques to calculate a utility based ranking of alternative strategies.

We find that because the level of interest rates can have a dramatic effect on the percentage of the value of a house that can be borrowed under a reverse mortgage, the reversionary interest is a highly risky asset with a mean and standard deviation of 16.4 and 40.5 percent respectively at age 65. Under a wide variety of assumptions, we find that the average household would be as much as one third better off taking a reverse mortgage in the form of a lifetime income immediately on retirement relative to the most widely used strategy of taking a line of credit when financial wealth is exhausted.