Reference no: EM131748704

Question: Jeanne Taylor is 60 years old and attempting to plan for her retirement over the next 25 years. She owns a house worth $165,000 with no outstanding mortgage. She wants to utilize the equity in her house to generate a supplemental income flow during this 25-year period. She has 2 alternatives: Alternative A The B.C. Trust Company offers her a special type of "reverse annuity mortgage". Under this type of ar rangement, the trust company will pay Ms. Taylor a 25-year annuity to supplement her annual income. In return, the company builds up a mortgage claim against Ms. Taylor's house, with the mortgage loan outstanding at any time amounting to the annual payments made to date, plus interest of 12 percent compounded annually on payments that have been made. The annuity that the trust company is willing to pay is such that, 25 years from now, the mortgage loan outstanding will amount to 75 percent of the currently assessed house value of $165,000. Alternative B Taylor can sell her house and rent equivalent housing accommodation at a fixed long-term rent of $12,000 per year. In selling her house, she would incur selling expenses of 6 percent of the sale price. Taylor would invest the proceeds from the sale of her house to yield interest of 8 percent per year before tax. She would withdraw equal annual amounts from these savings so as to draw the balance down to zero at the end of 25 years.

(a) Assuming all other housing expenses are identical for the two alternatives, and that Taylor is only concerned with her before-tax annual income over the next 25 years, which alternative should she choose?

(b) What other considerations would be relevant in reaching a final decision between these two alternatives?