So you're thinking of buying a retirement home, but you're still years away from retirement. Many of your friends already own a second house. But can you swing it?
We asked Barry Taylor, a certified financial planner with Bingham, Osborn & Scarborough, a wealth-management firm in San Francisco, to run some numbers. Of course, everyone's financial situation is different, but the three common scenarios we chose for review provide guidelines for many preretirees mulling a second-home purchase.
| Row 0 - Cell 0 | VIDEO: Before You Buy a Second Home |
| Row 1 - Cell 0 | TAX PLANNING: Buying a Second Home |
| Row 2 - Cell 0 | THE BASICS: Buying a Vacation Home |
Each scenario assumes that a couple, both 55, plan to retire in ten years. They have a $1 million portfolio growing at 8% a year. Several years ago, they refinanced their house for major renovations, so they still have a mortgage of $200,000 that they'll pay off in 12 years. Their house is now worth $500,000.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
The couple's annual disposable income is $60,000 -- after they pay income taxes, spend $35,000 on housing-related costs and make the maximum contributions each year to their 401(k) plans (at $20,500 each in 2007). They're considering a retirement house that costs $350,000. Both the first and second houses will appreciate by 2% a year.
Scenario One. The couple has $800,000 in their employer plans and $200,000 in a taxable account. "People tend to have more in their retirement accounts than in taxable accounts," Taylor says. The couple intends to take $70,000 from their taxable account as a down payment and borrow the rest with an 8% loan. Their yearly payment on the second house, including taxes and upkeep, will be $28,000.
The couple can reduce the annual payment by withdrawing more from their taxable account, but it's a "wash," Taylor says. After paying tax on their investment income, their return will be equivalent to the cost of the loan after they take the mortgage-interest deduction. However, he says, "If someone has a shorter time frame than ten years, you could be better off taking more from the portfolio, depending on the volatility of the market."
The couple can't afford the $28,000 of annual housing costs on their disposable income. So they will need to tap their taxable account, which they will drain within seven years. At that point, Taylor says, either they must withdraw from, or stop contributing to, their retirement accounts. Neither is a good idea, he advises. The verdict: They don't have enough money for the house. If they are determined to buy the second house, they must work longer.
Scenario Two. But let's say that the couple's portfolio is split equally between their 401(k)s and taxable account. They can pull the entire $350,000 from their taxable account, or they can withdraw part for a down payment and finance the rest. As in the first scenario, assume that the cost of the debt is the same as the forgone investment returns. Still, Taylor says, it makes sense to borrow for part of the costs. Otherwise, he says, "You're taking $350,000 from the portfolio bucket, which is earning 8%, and putting it in the house bucket, which is appreciating by 2%."
At the end of the ten years, the couple sells the first house for $610,000. After paying off the mortgage and sales-related charges, they will net $400,000, which they will use to pay off debt on the second house. The rest goes into the taxable account.
Scenario Three. The couple decides not to buy a new home until they retire at 65. The $1 million portfolio is split equally between retirement and taxable assets. By the time they buy, the retirement house will have risen in price to $425,000.
If building a nest egg is your top priority, Taylor says this scenario "makes the most sense." After selling the first house and buying the second, even at the higher price, the couple's nest egg will be $2.7 million. That compares to $2.4 million in Scenario Two, where the couple pulled out assets earning 8% a year to purchase a house appreciating by 2% a year.
With that extra $300,000 in their taxable account growing at 8%, the couple could boost their annual after-tax income for life by $16,000. That will enable them to hold off on tapping their tax-deferred retirement accounts.
-
457 Plan Contribution Limits for 2025Retirement plans There are higher 457 plan contribution limits for state and local government workers in 2025 than in 2024.
-
What Does Medicare Not Cover? Seven Things You Should KnowHealthy Living on a Budget Medicare Part A and Part B leave gaps in your healthcare coverage. But Medicare Advantage has problems, too.
-
13 Smart Estate Planning Movesretirement Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money.
-
Medicare Basics: 11 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
Six of the Worst Assets to Inheritinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2024 and 2025SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $69,000 in 2024 and $70,000 in 2025..
-
Roth IRA Contribution Limits for 2024 and 2025Roth IRAs Roth IRA contribution limits have gone up. Here's what you need to know.
-
SIMPLE IRA Contribution Limits for 2024 and 2025simple IRA The SIMPLE IRA contribution limit increased by $500 for 2025. Workers at small businesses can contribute up to $16,500 or $20,000 if 50 or over and $21,750 if 60-63.
