Buy The Nest, Keep The Egg

Even if you have the cash, financing your retirement home can make perfect sense

Even with the recent softening of the real estate market, many retirees are still getting so much for their homes that paying cash for a retirement property is not a problem. But if you're not ready to give up the main digs, how do you finance the new place? Even if you are ready to call the movers, is paying cash always the best way to go?

With these questions in mind, consider the many approaches you can take to paying for that home. You might have more options than you think.


Many people don't take mortgages because they want a debt-free retirement. The flip side is that you lose the tax deduction from paying interest, which can be helpful for higher-income retirees. A mortgage frees up cash for other investments, allowing you to diversify your holdings and lower your overall financial risk. If you do take a mortgage, real estate experts are cautioning borrowers to resist the lower-rate adjustable products, and lock in costs with a fixed-rate loan.

One exception is if you're looking for shorter-term financing. Financial planner Rob Hoxton of Shepherdstown, W. Va., has a client who is buying a house in Florida but hasn't sold his Pennsylvania residence. The solution was to take out a two-year adjustable-rate loan on the Florida property, which the client plans to pay off as soon as he sells the Pennsylvania house.


The options include refinancing with a conventional mortgage and withdrawing some cash for a downpayment, taking a home-equity loan, or getting a home-equity line of credit (HELOC). According to, the average interest rate is lowest on the mortgage, next lowest for the HELOC and the home-equity loan. The rate on a home-equity loan is fixed, while a refinancing loan can be either variable or fixed; a HELOC is variable and could turn out to be costly if rates continue to rise.


Denver financial adviser Paul Jeffery suggested to one client that he dedicate his $2,200 monthly Social Security payment toward the purchase of the $850,000 retirement home he's building. The client will take out a mortgage with monthly payments roughly equal to the Social Security check. That will get him a $362,000 mortgage at the current rate of 6.12%, and he will use proceeds from the sale of his current home to make up the difference. The rationale for this ploy: Social Security is a reliable stream of income that you know you'll get -- and you know when you'll get it. You can do the same with any regular pension or annuity payment.


If you or your spouse is 62 or older, and you own your home outright or have substantial equity, you may qualify for a reverse mortgage, which allows you to convert your home equity into a lump sum or an income stream.

Most people get a reverse mortgage to enable them to continue living in the same home. But real estate agents like Joanna Phillips in Santa Cruz, Calif., say you can get a reverse mortgage, take a lump sum to buy a rental property, and later, convert the rental property into a retirement home. The reverse mortgage carries closing costs, and you will have to pay the mortgage in full when you leave that residence, so be sure to crunch all the numbers before taking this route.


It's generally a bad idea to siphon money from a 401(k) or a traditional IRA because you'll owe regular income tax on the withdrawal and you'll lose the future value of the growth in your savings. If you're not yet 59 1/2, you'll owe an additional 10% early withdrawal penalty. High-bracket taxpayers could find this hit especially painful. (There is no tax or penalty on money withdrawn from a Roth IRA, unless it has been in the account less than five years.)

But there are better ways to get access to these funds. One is to use the Internal Revenue Service's "72(t)" provision, which allows for penalty-free early withdrawals of "substantially equal periodic payments" that spread your 401(k) savings over your life expectancy. Be aware that doing this commits you to taking the payments over a five-year period, or until you turn 59 1/2 -- whichever is longer. Failure to do so triggers a penalty.

Another way to tap this source is a 401(k) loan. Kathleen Ahern, a 51-year-old title insurance executive in Simi Valley, Calif., borrowed $50,000 at 6% from her 401(k) to cover most of the downpayment on a retirement home in California's Lake Arrowhead. The majority of, but not all, 401(k) plans allow loans. But the size will be limited to 50% of your vested funds, up to $50,000.


Do you have an unnecessary life insurance policy hanging around? Financial adviser Martin Shenkman of Teaneck, N.J., has a client who sold his business and no longer had to worry about replacing his earnings when he dies. Shenkman advised the client to cash in a whole life policy he had purchased many years ago and use the proceeds for a Florida condo he and his wife wanted to buy.


If you own an investment property, you might use a "1031 exchange" to trade it for a similar property that will become your future retirement home. The advantage of an exchange is to defer capital-gains taxes on the investment property you give up. But you must follow the IRS's strict rules and establish that your original intention was to use the new property for investment, not as your residence. That's why having a tenant with a lease is a good idea.

Financial planner Shenkman says there is no "bright-line" IRS rule on how long you have to keep the property as an investment before you can move in yourself. Once you've lived in the property acquired this way, selling it could be costly, warns Mark Steber, a vice-president at Jackson Hewitt Tax Service (JTX ) in Sarasota, Fla. The IRS, for instance, could "recapture" deductions you took for depreciation while the home was an investment property. In short, don't try this strategy without the help of a knowledgeable tax adviser.

By Ellen Hoffman

    Before it's here, it's on the Bloomberg Terminal.