Annuity offers mom peace of mind

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Dear Dr. Don,
I am looking for options on how to generate additional income for my 71-year-old mother. She lives in a home free and clear that is worth about $330,000. She receives $800 a month in Social Security benefits. I am considering two options to generate about $500 of additional monthly income for her:

1) Get a reverse mortgage that will allow her to stay in the house.

2) Sell the house and move into something in the $230,000 to $250,000 range.

Which option is best? If you believe option two is best, how would you invest the amount she would net from the sale of the house where she could get monthly payments?
— Raul Rumination

Dear Raul,
The right option depends on more than just which scenario generates an additional $500 in monthly income at the lowest total cost for your mother. Her health, her wishes to pass an estate on to her beneficiaries and the need for financial flexibility will all influence which decision is best for her.

It would be best for the two of you to consult with a financial planner to discuss this choice further. The Bankrate feature “Financial planners: Not just for millionaires anymore” can help you select the right financial planner.

A reverse equity mortgage would allow your mom to borrow against the house without having to make a monthly payment on the loan. She could get a line of credit using the reverse mortgage and then just draw down what she needs as she needs it. A rough estimate using the “AARP Reverse Mortgage Calculator” comes in at about $178,000 as an available credit line. The downside is that these mortgages have high closing costs and she has to remain in the house to keep the mortgage outstanding.

By downsizing she retains the option to get a reverse mortgage on the new house while freeing up cash to invest for income or to purchase a fixed-income annuity. Ideally, she’d also reduce her annual upkeep costs, homeowners insurance and property taxes by downsizing.

The hard part is estimating what she’d have available to invest after downsizing. If she netted $310,000 after real estate commissions and fees and used the money to buy a $240,000 house, she’d have about $70,000 to invest. Typically, that might purchase a single life income with no payments to beneficiaries of about $509 a month. Adding a guarantee of a five-year payment stream only reduces the monthly benefit to $502 a month.

Investing the money into financial assets other than a fixed-income annuity is unlikely to generate the money she needs with the certainty and security she requires. She’d need the $70,000 investment in my example to yield about 8.5 percent to generate $500 a month in income. Even if you assume $80,000 to invest, you’d need to earn 7.5 percent to generate $500 a month in income. You don’t want your 71-year-old mother swinging for the fences when it comes to investing for income.

To ask a question of Dr. Don, go to the “Ask the Experts” page, and select one of these topics: “Financing a home,” “Saving & investing” or “Money.” Read more Dr. Don columns for additional personal finance advice.