For many, retirement means a time to get out of the house and try something new. Maybe this means downsizing now that the kids are gone. Getting closer to the grand kids. Buying that dream lake house that you have always imagined while working those long hours. Or maybe, you are just looking to get out of the city and move to northern Michigan. Whatever the reason, making a move while you are in the process of retirement, can be tough to navigate. Not to mention, when you retire, getting financing can get more difficult without a job to show a steady stream of income. We’ll discuss some of the best options that you have for getting into that new home, without having to rely on selling your current home first.
Take Out a HELOC on your Current Property
This strategy typically only works if you have a a good amount of equity in your current property. A Home Equity Line of Credit (HELOC) is like a credit card that is tied to your property. Typically, you can only get a HELOC to 80% of your home value. For example, if your home is currently worth $300,000, you can take a HELOC up to $240,000. In this example, if you owe $100,000 on the property already, you could take out a $140,000 HELOC. This money could then go towards the new property. Once you sell your current home, you would end up paying off that HELOC and potentially be mortgage free once you retire.
The nice thing about going the HELOC route is that you don’t start paying on the HELOC and accruing interest until you use it. So, you can take out the HELOC while you are working and have it just sit there available to use. Take your time to purchase a home and once you do need the funds, you can use the HELOC and at that point start paying interest. It is also important that you plan ahead if you want to go this route. You won’t be able to take out a loan on your property if it is for sale, so you will need to take out a HELOC before you put your current home on the market.
Use Your After-Tax Funds to Purchase the Property
This strategy only works if you have a lot of after-tax savings, such as checking, savings, or a brokerage account. This DOES NOT work with pre-tax accounts such as an IRA or a 401(k). I can’t stress enough that you should not be taking a big distribution from an IRA to help pay off a mortgage or buy a new home once you retire. This could result in a huge taxable liability as well as put a huge dent in your retirement savings. If you are considering buying a property but don’t have the after-tax funds to do it, I would much prefer that you take out a mortgage instead on the new property as opposed to taking a large withdrawal from your pre-tax savings.
If you are dead-set on having no mortgage payment in retirement and only have pre-tax savings to pay off the loan, I have a different strategy for you. First, get a mortgage on the new home. Next, instead of paying off the mortgage all at once when you retire, do it over a 5 or 10 year period. This allows you to take smaller distributions each year, which limits your tax liability. Also, if the stock market is going up, the money in your pre-tax account can continue to grow for you until you withdraw the funds.
Of course, if you have after-tax dollars it may be more practical to use these funds to buy the new home or pay down a mortgage. You typically won’t have a high or maybe any tax liability when taking a large distribution from after-tax money. I would probably still prefer to keep the after-tax money in an account as opposed to paying off the mortgage all at once. This would allow you more flexibility in how you use the funds and you won’t get stuck in a situation in which you are house rich and cash poor. If you decide to pay off the mortgage in the future, great the money is available to do so. If you need the money for other retirement expenses, this is also fine because it isn’t tied up in your house.
60-Day IRA Rollover Rule
I just spent the last section discussing why you should never take out money from your IRA to buy a new home. This section I’ll explain the one exception to that rule. The 60-day IRA rollover is like taking a short term loan from your IRA, but if you don’t pay back the “loan” within 60 days the consequences are huge. First, let’s talk about how a 60-day IRA rollover works. You withdraw money from your IRA and withhold nothing for either federal or state taxes. You can then use the funds for anything that you need but you must replace the funds back into your IRA within 60 days of receiving the funds. The issue is that if you can’t replace the distribution within 60 days, you owe taxes (and penalties if under 59 ½) on the full amount of the distribution. The other issue is that, no matter how many IRAs you have, you can only do one IRA rollover within any 12-month period. Doing more than one 60-day rollover within a 12-month period will result in the second rollover being completely taxable.
The biggest issue of the 60-day rollover is that the tax consequences can be extreme if you can’t pay the funds back. Therefore, the 60-day rollover should only be used if you have a closing scheduled for both the sale and purchase of the new property and they are within close proximity. You can take a distribution from the IRA for a down payment on your new home and then replace the funds once you sell your old home. Obviously, this strategy only works if you can replace the funds quickly and you have enough equity in your current home to pay back the IRA distribution. Again, this strategy probably isn’t ideal because if something goes wrong and you can’t replace the funds it could be a killer for taxes. Yet, for certain known circumstances doing a quick short-term “loan” from your IRA can be useful.
I would really only consider a 401(k) loan as a last resort, but you may feel like you are down to last resorts trying to buy a new home at retirement. The nice thing about the 401(k) loan is that getting the funds are quick and easy and the interest that you pay back goes right back into your 401(k). The issue with taking out the 401(k) loan is that you can only take out up to $50,000 which may be a good down payment, but probably not enough to buy a new home. Also, unlike a mortgage, you can’t deduct the interest that you pay on a 401(k) loan. Last, typically a 401(k) loan is only 5 years which means that the monthly payment can be very costly. When you retire, if you still have an outstanding 401(k) loan, you will need to continue to make payments. If you stop making payments, you will be in default and pay taxes on the amount that you don’t pay back.
So, why would you consider a 401(k) loan for buying a home? Again, the hope with the 401(k) loan is that you could use the proceeds for a down payment on a new home so that you can finance the rest of the property. Typically, a person has to put down 20% on a new home to qualify for a conforming home loan and also avoid private mortgage insurance (PMI). If you are buying a retirement home, like I mentioned before, you probably want to do it before you retire. If you don’t have other funds for a down payment, a 401(k) loan can help you get into that new home. You really don’t want to continue to pay the high monthly 401(k) loan payments in retirement, so when you do sell your property, you can use the proceeds to pay off the home.
Here’s a few finance tips for buying that dream retirement home:
- Consider buying the new retirement home before you retire, as this gives you more and easier finance options than waiting until after you retire
- Unfortunately, this may mean owning two homes until you sell your current property
- If you have equity in your current property, you can take out a HELOC prior to retirement on your current home and use the proceeds to buy the new home
- Consider using any after-tax money for the down payment on the property and don’t be scared to finance the rest
- If you don’t have the funds for a down payment consider a short-term 401(k) loan which you will pay off when you sell your current residence
- Avoid taking large distributions from your IRA or 401(k) to pay off your mortgage
- A 60-day IRA rollover can act as a short-term “loan” but make sure you have a solid plan to pay the money back within 60 days
There is a lot to worry about as you transition in retirement and buying a new home is not easy. When do you buy your new home? How long will it take to sell your current property? Where will the down payment come from? Do you throw all of the things away that have been accumulating in your attic for the past 30 years? Having a solid plan though can help you get into that new home and give you one less thing to worry about when you retire.