Tax-Free Resources for the Cash-Strapped Elderly

Inflation, inadequate retirement planning, medical costs, retiring too early and financial casualties can all strain the financial resources of elderly individuals. When looking for financial resources to supplement their existing retirement income, one might consider one or both of the following options.

Home Equity – Home equity is a large asset that can be tapped. However, selling the home is not always a good option since elderly individuals generally wish to remain in their home. Refinancing through conventional loans will provide temporary funds. Unfortunately, the loans come with a repayment requirement that increases the monthly cash needs and may be counter-productive.

However, "reverse mortgages" allow homeowners to remain in their homes while borrowing against the equity they have built up in their dwellings without any current mortgage payments.

If the homeowner dies, the heirs can pay off the debt by selling the house and any remaining equity goes to them. If, at that time, the loan balance is equal to or more than the value of the home, the repayment amount is limited to the home's worth.

In order to be eligible for this type of loan, the borrower must be at least 62 years of age and have equity in the home. The loan amount will depend on factors such as the borrower's age, the value of the home, interest rates and the amount of equity built up. The borrower has the option of taking the loan as a lump sum, a line of credit, or as fixed monthly payments. In addition, the money can be used for any purpose, without restrictions imposed.

Life Insurance Contracts - If a taxpayer is terminally or chronically ill(1) and is insured under a life insurance contract, he or she might consider tapping their insurance death benefits while still living. This type of transaction is called a “viatical” settlement and is generally tax-free if an individual is certified to have a life expectancy of two years or less.

Here is how it works. The policy owner sells the policy to a third-party buyer. The buyer is responsible for future premium payments and will receive the proceeds of the insurance policy when the insured dies. In some cases and under certain conditions, an accelerated death benefit may be available directly from the insurance company itself. The payments will be less than the face value of the policy, usually between 60% and 80% of the face value, depending upon the insured's life expectancy, annual premium, etc. Lifetime payments received under a life insurance contract of a terminally or chronically ill individual are excludable from taxable income.

(1) For chronically-ill individuals, payments are tax-free only if the individual is certified by a licensed health care practitioner as unable to perform, without substantial assistance, at least two activities of daily living for at least 90 days due to a loss of functional capacity, or as requiring substantial supervision for protection due to severe cognitive impairment (memory loss, disorientation, etc.)

Viatical settlements are also possible for individuals who are not terminally or chronically ill, but the settlement is treated as a sale of the policy, and the gain on the sale is taxable, which may or may not be an issue based on the taxpayer's other income and the amount of the settlement.