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Press coverage around reverse mortgages has grown more positive in recent years as new research has helped to explain how they can improve the prospects of an overall retirement income plan. However, a lingering question remains about the costs of reverse mortgages. Costs can be high, which leaves people wondering how their benefits can be justified.

In isolation, reverse mortgages can look expensive, and one might question the motivations of those researchers who argue that reverse mortgages can add value. But reverse mortgages should not be viewed in isolation. They are a piece of a larger puzzle that retirees are trying to solve. Reverse mortgage costs can be offset by gains elsewhere in the overall financial plan. To show this, I’ll create an example to illustrate how a reverse mortgage, by protecting the investment portfolio in retirement, creates a net positive result despite its costs.

The power of a reverse mortgage to help preserve an investment portfolio in retirement can be viewed in any number of ways. For instance, a reverse mortgage could be used to refinance a traditional mortgage to avoid making mortgage payments in the key early years of retirement; it could be used to build a bridge to support the delay of Social Security benefits without taking excess distributions from an investment portfolio; or it could be used to coordinate distributions from an investment portfolio to avoid creating greater pressure on the portfolio when markets are looking bleak.

I’ll show an example of the last point, as this is where most of the research about reverse mortgages has focused, starting with Barry and Stephen Sacks’ seminal article1 on reverse mortgages published in 2012.

For the example, I’ll assume a 65-year old retiree who has $1 million in an IRA and a home worth $200,000. The home is fully paid off. She uses a 50/50 asset allocation, rebalanced annually and divided between the S&P 500 and intermediate-term U.S. government bonds. I’ll use historical market returns from 1966 to 1995. This is a valuable series of data to use because it was the years that gave the financial planning world the 4% rule-of-thumb for retirement spending. Over those years, one could withdraw just 4.038% of their retirement date investment assets and sustain that level of spending with inflation adjustments for 30 years without depleting the assets. I’ll also assume that the home’s value grows at the Case-Shiller Home Price Index returns over that period.