How much can I afford to pay for a home and still maintain a comfortable retirement without worrying about running out of money?
I’m 66 and I have about $1.78 million in a taxable investment account, $1.5 million in IRAs, $309,000 in a Roth and $115,000 in a deferred compensation plan. I also have a long-term care insurance policy and $60,000 in an HSA.
I’m waiting until age 70 to begin taking Social Security, which will be about $4,600 per month. I do not currently own a home or any real estate. Once I buy a home, I expect $60,000 per year to be adequate to cover all of my expenses.
What is the best way to fund a home purchase in the next one to two years? What are the tradeoffs and tax implications of a cash purchase (and the long-term capital gains to fund that) vs. carrying a mortgage?
– Doug
Your question is simple enough but the answer may be different for each person depending on personal nuance. However, if we look at the big picture you should be able to get a ballpark idea of what you can potentially afford. It should also help clarify the avenues to consider. You can then narrow it down from there based on your personal preferences. Working with a financial advisor or tax professional is likely a good idea, as they can help you identify a specific route to take.
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There will be a lot of nuance when it comes to figuring out how much house you can afford to purchase in retirement, but it may be helpful to start by thinking about your withdrawal rate after the purchase.
I like using the 4% rule as a starting point, but you’ll need to tailor your personal withdrawal rate based on your own assumptions, including expected returns, longevity and whether you have a plan for adjustments. It will likely take some time to figure out a withdrawal rate you’re comfortable with.
If $60,000 is your planned spending, then you’d need approximately $1.5 million savings if you follow the 4% rule. Increasing your withdrawal rate to 5% means you’ll need around $1.2 million in savings to withdraw $60,000 (and then adjust your distributions upward for inflation). If you opt for a lower withdrawal rate – say, 3% – you’ll need to start with a $2 million nest egg.
These targets are conservative because they don’t account for your Social Security payments, which won’t start for a few years. Those will cover almost all of your spending on their own once that begins. You may want to subtract the net value of those payments from your annual spending target. If you do, set aside enough money to cover your spending needs until it begins and redo the calculations above.
You mentioned that you have long-term care insurance, which is good. You also have a healthy HSA balance. Assuming you have enough set aside for emergencies and other unplanned expenses, you could theoretically spend the rest of your savings on a home. Since you have about $3.7 million in savings that’s quite a bit of money you’d be able to use toward a home purchase if you wanted to.
The vast majority of people would be very happy spending much less than they can reasonably afford in this situation, and I imagine that will be the case for you too. (But if you need additional help managing your income and expenses in retirement, or setting a home purchase budget, match with a financial advisor and talk it over.)
Again, personal preference is going to play a major role in determining how to fund your home purchase. Your two basic choices of course are to pay cash or finance it with a mortgage. Here’s how to think about both options.
This is the most straightforward option. Since you have the funds available, you could purchase the home outright, eliminating the need for a mortgage. While this would reduce your savings or investment balance, it also means you won’t have a monthly payment or interest costs. In a way, using investment dollars to avoid borrowing is similar to buying a bond – rather than earning a fluctuating return, you’re effectively securing a guaranteed “return” by avoiding a fixed interest expense.
Depending on the cost basis of the various holdings in your taxable account, I’d start by looking there for what you might be able to sell for minimal gain. To the extent you have to recognize a gain to pay for the house with cash, focus on long-term gains. Even still, it may be a good idea to stagger the capital gains across more than one tax year. Depending on how much it is, this may allow you to avoid the 20% rate.
You could also choose to take out a mortgage. The lower the interest rate, the more appealing this option becomes. With current rates around 6.5-7%, paying in cash may seem more attractive compared to periods of lower rates. To use the earlier analogy, avoiding a mortgage is like buying a bond – except in this case, it would be one with a 6.5-7% return. That’s pretty good for a 30 year term!
Again, you can evaluate this choice by calculating your withdrawal rate. Here, you’re going to add your monthly mortgage payment to your other outlays to arrive at a total amount of income you need. Then, divide that by your total amount of savings and investments. Once again, you can also factor in expected Social Security benefits when assessing long-term affordability.
(And if you need additional help weighing your options, work with a financial advisor who offers financial planning services.)
Based on what you’ve mentioned, I think spending up to $2 million on a house wouldn’t be unreasonable. But as I said, you’ll need to spend some time thinking about what you’re comfortable with and how much of a home you even want to buy.
This isn’t one of those questions you can answer with only a calculator. The math will help you see what a reasonable price range might be. Understanding your personal comfort level, and what you consider to be optimal, is an absolute must for making the right decision.
Retirement planning can be nuanced and complex. Figuring out how much money to save and how much income you’ll need in to support yourself once you stop working are vital pieces of the puzzle. Fortunately, SmartAsset’s retirement calculator can help you do the heavy lifting. This free tool can help track your progress toward your savings goal and project how much income your savings will produce.
A financial advisor can help you customize a retirement plan that’s built on your savings, needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not an employee of SmartAsset and is not a participant in SmartAsset AMP. He has been compensated for this article.Some reader-submitted questions are edited for clarity or brevity.
