Avoid Costly Mistakes When Buying Real Estate in Retirement

You’re ready to retire and tackle your bucket list. On your list is buying that dream home in retirement. But how do you pay for it? You should avoid these costly mistakes when buying real estate in retirement.

Whether you want to buy your dream home by the lake or the ocean of somewhere more exotic, you’re probably wondering how to make this dream a reality so you can cross it off your personal bucket list. Recently, I was asked by a retired couple whether using retirement funds for the down payment was allowed and if it was a good idea.

My response?

Sure, what you want to do is allowed but it will cost you.

You ought to look at the really BIG picture here and not just focus on the mortgage payment on your new home.

By taking $100,000 out of your retirement account, you’ll find that this total amount is added to your gross income (unless you’re taking it out of any Roth 401(k) portion of your plan).

How much this impacts your taxes really depends on the amounts and composition of all your other income. Presumably, you’ll have your W2 earnings for the year through the date of retirement. You’ll also need to add in any dividends and capital gains from your non-retirement assets. If you have Social Security benefits, you’ll find that 85% of this total will be added into your total income to add to what is taxed.

Some of this may be offset by your itemized deductions (i.e. mortgage interest, property taxes and mortgage interest paid, charitable deductions). But if you had large amounts paid out for medical insurance premiums (including Medicare Part B and D premiums), medical mileage and out-of-pocket medical expenses, you may find that no portion of this will be tax deductible. Why? You may only deduct that portion which is above 7.5% of your adjusted gross income (AGI) with some/few exceptions. Assuming the retirement distribution was your only income (not likely but just for illustration), then you’d find that only the amounts over $7,500 in medical expenses may be deductible.

Speaking of Medicare, you may find that you’ll end up paying for your Medicare Part B because the distribution may push you into a higher bracket. If your modified adjusted gross income (MAGI) is about $170,000 when filing jointly, you’ll find your Part B premium will go up about 40% from $134/month per beneficiary to $188/month. There is a similar increase for the presecription drug plan (Part D).

This publication from Social Security will detail this better: https://www.ssa.gov/pubs/EN-05-10536.pdf .

What’s not been discussed here yet is the impact of using these proceeds for a home purchase versus using them to supplement your retirement cash flow needs. You may find that $100,000 at least or $450,000 in total might be better allocated to investments that generate income (i.e. REIT stocks or high-dividend-paying stocks). Allocated to something like the Vanguard Dividend Appreciation Index Fund (VDAIX) which has an average 2% yield, you would generate $9,000/year in income. Something like the iShares Select Dividend ETF (DVY) which pays out slightly more than 3% and you’re looking at $13,500 in additional income. That goes a long wa toward paying the property taxes on your new home.

Another option that you may find will work better: a Home Equity Conversion Mortgage (HECM). While terms may vary, you’ll find the most competitive options are offered at under $200 in closing fees. This can be used to purchase a property. You can use it to fund up to 50% of the purchase price. And there is zero income tax or Medicare premium impact. Another great thing that this offers is flexibility. Unlike a conventional mortgage, you don’t have to make payments which can help you with your cash flow. While it may be paid at any time, it allows you to keep your investments working for you. And research shows that the portfolios of those who use a HECM last longer since they don’t have to draw down on investments to pay for living expenses when the market is down.

Before you invest in your retirement dream home, you may want to invest some time and money with a qualified fiduciary financial planner who can help you sort through the impacts of all of these options.