Tax season can seem like an overwhelming time of year. As you’re busy gathering all the receipts, statements and other necessary documentation on your retirement assets, you might want to consider how alternative investments, like getting a reverse mortgage, can impact your retirement taxes.
In recent years, reverse mortgages have been garnering greater acknowledgement within the financial planning community as viable financial tools to supplement a person’s retirement portfolio. However, these loans aren’t one-size-fits-all assets and their effectiveness and tax implications may only be right for you depending on your particular financial situation.
“There are many reverse mortgage tax implications that borrowers should and need to consider and can actually be a huge benefit,” says Brian Cook, mortgage advisor and reverse mortgage specialist at Alpine Mortgage Planning in Federal Way, Washington. “In all matters of these, however, they should always seek out a CPA to help determine any positive or negative results.”
Reverse Mortgage Tax Implications — The Benefits
The proceeds received from a reverse mortgage are not susceptible to federal or state income tax and can be used however the borrower may so choose. Reverse mortgage proceeds also do not affect regular Social Security or Medicare benefits. (Although, a reverse mortgage can impact Medicaid eligibility. Be careful if you are or might be eligible for Medicaid.)
One tax benefit of a reverse mortgage could apply to those looking to save on their taxes. If a borrower does not have a mortgage, or if they’re paying off a small Home Equity Line of Credit (HELOC), they could actually lower their taxable income through a reverse mortgage, says Cook.
For higher income borrowers who are worried about retirement taxes and who may be taking more than the minimum required distribution from their retirement assets, they could lower their draw on these taxable assets by using a reverse mortgage to supplement the difference, which would in turn produce significant cost savings down the road.
“By lowering their distributions, which is taxable in many retirement plans, and making up the difference with a draw on their equity through a reverse mortgage—a non-taxable event—they could sometimes save thousands in taxes over a period of time,” Cook says.
Retirement Tax Planning — Reverse Mortgage Tax Implications on Home Mortgage Deductions
Even though you aren’t making payments to a lender as you would on a traditional “forward” mortgage, interest accrues on the reverse mortgage proceeds you do receive, which can have an impact on your home mortgage interest deduction.
A home mortgage interest deduction allows taxpayers who own their homes to reduce their taxable income by the amount of interest paid on any loan used to build, purchase or make improvements on their residence.
With a reverse mortgage, interest is not paid out of your available loan proceeds, but instead compounds over the life of the loan until repayment. That means for income tax purposes, specifically when it comes to your mortgage interest deductible, interest charges on reverse mortgages can only be deducted once they have been paid.
Repayment of a reverse mortgage usually occurs when the borrower vacates the home for more than 12 months, decides to sell the home or dies — in the event of which the borrower’s heirs or surviving spouse (if applicable) are then responsible for paying back the loan.
Your deduction may also be limited because reverse mortgages are generally subject to a limit on home equity debt, meaning you can deduct the interest on no more than a loan of $100,000, according to the Internal Revenue Service.
“Another implication could be the loss of the mortgage interest write-off if a homeowner is paying off a mortgage,” says Cook. “Many higher- and middle-income borrowers utilize this to offset the taxes they owe, especially those in higher tax brackets.”
One way to combat this, Cook adds, is to make payment on their reverse mortgages, which could result in write-offs as well.
Retirement Tax Planning: Consider Expert Help
To find out if a reverse mortgage is right for you, consider sitting down with both a reverse mortgage specialist as well as a financial planner to get a more holistic view on how these loans, and their tax implications, can affect your retirement plans.
“Not only is this helping their tax decisions, but also many times educates the CPA on the benefits for their clients as well,” says Cook.
