More and more retirees are making the decision to keep their primary residence in retirement but also own a second residence, whether that be a lake house, ski lodge, or a condo down south.  Maintaining two houses in retirement requires a lot of additional planning because you need to be able to answer the following questions:

 

• Do you have enough retirement savings to maintain two houses in retirement?

• Should you purchase the house before you officially retire or after?

• Are you planning on paying for the house in cash or taking a mortgage?

• If you are taking mortgage, where will the down payment come from?

• Will you have the option to claim domicile in another state for tax purposes?

• Should you setup a trust to own your real estate in retirement?

 

Adequate Retirement Savings   

 The most important question is do you have enough retirement income and assets to support the carrying cost of two houses in retirement?   This requires you to run detailed retirement projection to determine what your total expense will be in retirement including the expenses associates with the second house, and the spending down of your assets over your life expectancy to make sure you do not run out of money.  Here are some of the most common mistakes that we see retirees make:

 

1. They underestimated the impact of inflation.  The ongoing costs associated with maintaining a house such as property taxes, utilities, association dues, maintenance, homeowners insurance, water bills, etc, tend to go up each year.  While it may look like you can afford both houses now, if those expenses go up by 3% per year, will you have enough income and assets to pay those higher cost in the future?

2.  They forget about taxes.  If you will have to take larger distributions out of your pre-tax retirement accounts to maintain the second house, those larger distributions could push you into a higher tax bracket, cause your Medicare premiums to increase, lose property tax credits, or change the amount of your social security benefits that are taxable income.

3.  A house is an illiquid asset.  When you look at your total net worth, you have to be careful how much of your net worth is tied up in real estate.  Remember, you are retired, you are no longer receiving a paycheck, if the economy hits a big recession, and your retirement accounts take a big hit, you may be forced to sell that second house when everyone else is also trying to sell their house.  It could put you a in a difficult situation if you do not have adequate retirement assets outside of your real estate holdings.

 

Should You Purchase A Second House Before You Retire?

 Many retirees wrestle with the decision as to whether to purchase their second house before they retire or after they have retired.   There are two primary advantages to purchasing the second house prior to retirement:

 

1. If you plan on taking a mortgage to buy the second house, it is usually easier to get a mortgage while you are still working.  Banks typically care more about your income than they do about your level of assets. We have seen clients retire, have over $2M in retirement assets, and have difficulties getting a mortgage, due to a lack of income.   

2. There can be large expenses associated with acquiring a new piece of real estate. You move into your second house and you learn that it needs new appliances, a new roof, or you have to buy furniture to fill the house.  We typically encourage our clients to get these big expenses out of the way before their paychecks stop in case they incur larger expenses than anticipated.

 

Mortgage or No Mortgage?

 The decision of whether or not to take a mortgage on the second house is an important one.  Sometimes it makes sense to take a mortgage and sometimes is doesn’t. Many retirees are hesitant to take a mortgage because they realize having a mortgage in retirement means higher annual expenses. While we generally encourage our client to reduce their debt by as much as possible leading up to retirement, there are situations where taking out a mortgage to buy that second house makes sense.

 But it’s not for the reason that you may think.  It’s not because you may be able to get a mortgage rate of 3% and keep your retirement assets invested with hopes of achieving a return of over 3%.   While many retirees are willing to take on that risk, we remind our clients that you will be retired, therefore there is no more money going into your retirement accounts.  If you are wrong and the value of your retirement accounts drop, now you have less in assets, no more contributions going in, and you have a new mortgage payment. 

 

In certain situations, it makes sense to take a mortgage for tax purposes.  If most of your retirement saving are in pre-tax sources like Traditional IRA’s or 401(k)’s, you withdrawal a large amount from those accounts in a single year to buy your second house, you may avoid having to take a mortgage, but it may also trigger a huge tax bill.  For example, if you want to purchase a second house in Florida and the purchase price is $300,000.  You take a distribution out of your traditional IRA to purchase the house in full, you will have federal and state income tax on the full $300,000, meaning if you are married filer you may have to withdrawal over $400,000 to get to the $300,000 that you need after tax to purchase the house.  

 

If you are pre-tax heavy, it may be better to take out a mortgage, withdrawal just the down payment out of your IRA or preferably from an after tax source, and then you can make the mortgage payments with monthly withdrawals out of your IRA account. This spreads the tax liability of the house purchase over multiple years potentially keeping you out of those higher tax brackets.

 

But outside of optimizing a tax strategy, if you have adequate after-tax resources to purchase the second house in full, more times than not, we will encourage retirees to go that route because we are big fans of lowering your fixed expenses by as much as possible in retirement.

 

Planning For The Down Payment

 If we meet with someone who plans to purchase a second house in retirement and we know they are going to have to take a mortgage, we have to start planning for the down payment on that house.  Depending on what their retirement picture looks like we may:

 

• Determine what amount of their cash reserves they could safely commit to the down payment

• Reduce contributions to retirement accounts to accumulate more cash

• If their tax situation allows, take distributions from certain types of accounts prior to retirement

• Weigh the pros and cons of using equity in their primary residence for the down payment

• If they have permanent life insurance policies, discuss pros and cons of taking a loan against the policy

 

Becoming A Resident of Another State

 If you maintain two separate houses in different states, you may have the opportunity to have your retirement income taxed in the more tax favorable state.  This topic could be an article all in itself, but it’s a tax strategy that should not be overlook because it can have a sizable impact on your retirement projections.  If your primary residence is in New York, which is a very tax heavy state, and you buy a condo in Florida and you are splitting your time between the two houses in retirement, knowing what it requires to claim domicile in Florida could save you a lot of money in state taxes.  To learn more about this I would recommend watching the following two videos that we created specifically on this topic:

 Video 1:  Will Moving From New York to Florida In Retirement Save You Taxes?

Video 2:  How Do I Change My State Residency For Tax Purposes?

 

 Should A Trust Own Your Second House

 The final topic that we are going to cover are the pros and cons of a trust owning your house in retirement.  For any house that you plan to own during the retirement years, it often makes sense to have the house owned by either a Revocable Trust or Irrevocable Trust.   Trust are not just for the ultra wealthy.  Trust have practical uses for everyday families just as protecting the house from the spend down process triggered by a long term care event or to avoid the house having to go through probate when you or your spouse pass away.  Again, this is a relate topic but one that requires its own video to understand the difference between Revocable Trust and Irrevocable Trusts:

 Video:  Should You Put Your House In A Trust?

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.