Need Perspective - Cash or Mortgage for Retirement Home

[RedSox1]

Active duty military retiring in next 2-3 years and looking for a sanity check on the purchase of "retirement" home. Hoping to get some wisdom from the crowd before paying Facet Wealth or other financial advisor.

We currently have ~$750,000 in taxable accounts that plan to use to purchase a house and support discretionary spending from age 52-60. Will have COLA adjusted pension of ~$120,000 per year starting in 2026 and anticipated annual expenses of ~$131,000-$150,000 (minus a mortgage). This includes ~$85,000-$90,000 of "mandatory expenses" that include taxes and health care. Currently debating whether to pay cash for a house (up to $600,000) or take a mortgage of up to $300,000 at current rates of ~6% resulting in payment of ~$2500/month.

We have not yet found the house but am exploring options and want to be ready to move if an opportunity presents. Intuitively I want to avoid debt going into retirement and am leaning towards paying cash but am not sure what I might be missing.

Additional Information:
- Solidly in the 22% tax bracket now and anticipate same in retirement given pension.
- OPTION 1: Pay in cash. This avoids paying interest and keeps expenses down in retirement but requires paying capital gains on ~$75,000-$110,000 depending on which funds we sell. To keep capital gains lower would mean selling more VTSAX and VTIAX and retaining less tax-efficient funds in taxable. This would increase tax drag on my portfolio going forward and impact my ability to fully transition to Three-Fund portfolio.
- OPTION 2: Take a mortgage. This comes with lower capital gains (~$55,000) and maintains larger taxable balance providing more liquidity. However, could reduce my ability to make catch-up contributions to ROTH TSP during remaining work years and increased risk of failure in Firecalc if exceed $175,000 spending annually.

- We are currently renting and can stay in place through 2026. Rent is $2950 per month and is not included in anticipated expenses for retirement as have assumed we will buy a house prior to retiring.
- Will invest ~$45,000 per year through 2026 when retire from military - mostly in ROTH TSP and IRAs given catch-up contributions once I turn 50. All tax-advantaged accounts are in ROTH so no RMDs or conversions in the future.
- Firecalc gives me a 100% chance of success over 47-years with budget ranging from $150,000-$175,000 dropping to 95% at $180,000
- I am able and willing to work past 52 if lack confidence in numbers but would like to have the option of fully retiring at 52-53

Questions
- Does it make sense to pay cash? This would push me into the 24% tax bracket for 2024 given capital gains.
- Am I missing anything in my basic assessment of the two options? Is there a better way to fund a home purchase to limit capital gains?
- Is there any reason to consider using ROTH IRA funds to fund home purchase (i.e. lower capital gains paid)? This will be the second house we have bought so not sure can use ROTH to fund.

I have benefited in the past from the wisdom of this forum and appreciate any perspective Bogleheads are willing to share.

[Meg77]

I would pay cash. Don't let the tax tail wag the dog. It sounds like you'll have pay the gains either way if the taxable account is going to supplement your pension for the first 8 years of retirement. The only question is when you'll pay them - gradually over those years as you draw the portfolio down to pay the mortgage and the rest of your income gap, or mostly in 2024 when you buy the home. They'll be taxed at 15% either way if you'll be in the 22-24% bracket though. For the record you could sell some this calendar year and split the gains between 2023 and 2024 at least if that helps prevent the 2024 slight tax bracket increase.

Taking on a mortgage that is all but guaranteed to cost more than the fixed income portion of your portfolio will generate seems silly in my view, especially now that rates are extremely unlikely to rise much further. When mortgage rates were 3% the calculus was the same, if a little more understandable. People who owned $500K in bonds paying 2% several years ago generally shouldn't have borrowed $500K against a home at 3%. They may be patting themselves on the back now for their 3% loans, but they conveniently separate that from the hefty losses they have sustained in their bond portfolios over that time period.

It's one thing - and a much riskier thing - to take on a mortgage to invest in stocks or private equity or even investment real estate. It's quite another to do so when you own bonds. But to be honest even stocks may struggle to return enough to make the arbitrage and sequence of returns risk worth it on a 6-7% mortgage.

[Nords]

The most important part of your home purchase is sleeping comfortably at night. If carrying a mortgage makes you (or your spouse) uncomfortable then bite the bullet and pay cash. It certainly gives you more negotiating power on your offer, as well as a faster close.

You’re smart to plan ahead on the home purchase, as long as you’ve explored all of the issues. One of the most stressful transitions you could attempt in your life is trying to buy a home when you’re retiring from the military and still sorting out your bridge career. Here’s more on those challenges from an old post at the Internet Archive:
https://web.archive.org/web/20211023135809/https://the-military-guide.com/dont-buy-home-leave-active-duty/

Keep in mind that the size of your capital gains might also push you into the Net Income Investment Tax as well as higher state & local income taxes. Do the spreadsheet math on both approaches of paying cash or with using a mortgage... but pay more attention to your emotions of behavioral financial psychology than you do to your math & logic.

(Side note: If you’re wiring a large chunk of cash to a title company, be very careful with their wire-fraud precautions at both your brokerage and at the title company. Fidelity seemed to have good wire-fraud precautions when we bought a house (with cash) in 2020, but the seller’s title company was surprisingly freaked out by our questions about wire fraud.)

Now about the mortgage: you have a couple of rare opportunities to arbitrage a long-term fixed-rate loan and a military pension.

First, it’s a lot easier to borrow money when you can show reliable earned income. Lenders care far more about income than assets. If you have a W-2 from the military (or a civilian bridge career), that makes lenders a lot happier than any sort of 1099, let alone a 1099-R. If you’re not immediately starting a bridge career (perhaps taking a year or two of a mini-retirement) then apply for a mortgage before you deposit your last military paycheck.

Second, consider offsetting a 30-year mortgage with an inflation-adjusted military pension. Yes you’re paying lots of interest, but you’re also getting annual cost-of-living adjustments to your pension. Over the last 20 years, the military’s pension COLA has risen at an average annual compounded rate of just over 2.2%. (That includes three years of zero COLAs.) During those 20 years, my military pension has risen by 67.7% from 2002.

I won’t claim that you’re going to make more money by keeping your assets in the stock market, although you’ll certainly avoid paying higher income taxes now. (I doubt that bond dividends will be as high as a mortgage rate.) With a mortgage, though, you can choose to pay a few years of interest on a home that meets all of your criteria while keeping the option to make fixed P&I payments from a pension that rises with inflation. There’s even the possibility of refinancing once or twice in the next 30 years.

Depending on the amount you borrow, you might even pay less interest during the next few years than you'd pay in income taxes from cashing out your investments.

Once you start collecting your military pension (and perhaps start your bridge career) then you can decide whether to cash out to pay off the mortgage-- or simply accelerate your mortgage payments from your discretionary income.

[RedSox1]

Nords,

Thanks for taking the time to respond. As a long-time follower here I always appreciate your perspective. The link to the old post was very helpful and amplifies the importance of timing.

The SWAN factor is important and intuitively I dislike debt so paying cash is appealing to me. That said I do need to run some more numbers in terms of state/local taxes and am now considering splitting the difference by taking a 15-yr mortgage with intent of paying it off in full (~7-8 years early) once I have unrestricted access to my retirement accounts. This would cost me ~$55-65,000 in interest but would allow me to stress test my retirement budget and give me additional flexibility prior to 59 1/2 while allowing taxable funds to remain invested. We are comfortable with a higher level of risk then many due to stability of military pension and plan to remain ~80/20 throughout retirement.

In your reply you mentioned 30-year mortgage (lowers payment by ~$600 per month). Would a 15-year mortgage be any different? I like the idea of paying more principal each month with the 15-year allowing me to pay off the mortgage more quickly.

Thanks again for the time and perspective.

[RedSox1]

Meg77,

Thanks for the perspective. I am sensitive to the idea of letting the "tax tail wag the dog" and acknowledge the gains will have to be paid either way. Intuitively paying cash avoids paying the interest for a mortgage but ties up significant portion of taxable funds in an illiquid asset. Greatest benefit would be the simplicity and ensuring can SWAN - a lot to be said for that.

A lot to think about and really do appreciate your thoughts.

[Nords]

In your reply you mentioned 30-year mortgage (lowers payment by ~$600 per month). Would a 15-year mortgage be any different? I like the idea of paying more principal each month with the 15-year allowing me to pay off the mortgage more quickly.

We’ve arbitraged mortgage interest rates against the stock market for nearly 20 years, so we favor 30-year mortgages whose lower payments are easier to handle within an O-4 20-year pension. We cover our retirement spending from my pension and from cashing out our investments at the 4% Safe Withdrawal Rate.

We started with a 30-year interest rate of 5.375%. Over the long term (>10 years) we’ve made money on after-tax returns of ~8%/year (yet very volatile) while refinancing whenever it made sense. A few percentage points doesn’t seem worth the effort, but the more money you leverage then the more the dollar value of the arbitrage affects your personal income.

(For others not familiar with this tactic: yes it's eye-popping risky. We're borrowing against future inflation-adjusted pension dollars and investing them in the stock market while putting up our personal residence as collateral. Why, for this tactic to fail, the U.S. federal government would have to stop paying military pensions.)

In 2017 we doubled down on this tactic with a cash-out refi of $636K at 3.5% for 30 years, which amortizes at $2,856/month. At the time that P&I payment fit my pension well ($3577/month), and the COLAs since then have boosted it to $4439/month today. We’ll pay off that mortgage for my 87th birthday, and by then the payment will have been eroded by 29+ years of inflation to about a third of its 2017 value.

Of course if I die tomorrow then my pension vaporizes and this tactic is a miserable fail, but we have enough assets to cover a longevity contingency. Or you’d hedge the risk with a term life-insurance policy.

That’s all math & logic, but as you’ve noted... sleeping well at night is far more important.

A 15-year mortgage will cost less interest, but you could do the math for both loan terms to figure out which fits your budget the best. You know the mortgage payment won’t go up, and you can be pretty confident that your pension COLA will average about 2%-3%/year.

Another tactic would be borrowing money as a 30-year loan and then paying it off at your personal 15-year amortization schedule with extra principal payments. You have the personal discipline to stick to that plan, but if you hit a bear market or a recession then you could give yourself another ~$600/month of margin by reverting to the 30-year P&I payment for a few months.

The catch to this 15-vs-30 tactic is that you’d pay a higher interest rate for the 30-year loan, but again you’d work with a mortgage broker for the best options and then check the math of each.

[deserat]

Hi Nords!

I've come here to say I will be paying cash for my house which will be finished in Feb. I know Nords from a long time ago....his approach is not for the faint of heart, but his rationale is sound. Nevertheless, for some it is an emotional as well as rational decision. I am in a similar position as him, however, for my peace of mind, I want no mortgage....

As many say, there are many ways to skin a cat.

You will probably be fine either way.

I think the main anchor to his rationale is the gold-plated military pension. If that cannot be paid, the environment is very bad and there will probably be much more important issues to deal with than paying your mortgage. The second thing in his favor is the extreme DIY gene he has that drives down his lifestyle costs to probably the lowest possible outside of just going without. It's just lately he has loosened his purse strings....so on offense and defense he has optimized his positions.

If you can do the above, not necessarily as extremely as him, and you can manage any emotional swings, his approach would probably work for you.

[deserat]

Hi Nords!

I've come here to say I will be paying cash for my house which will be finished in Feb. I know Nords from a long time ago....his approach is not for the faint of heart, but his rationale is sound. Nevertheless, for some it is an emotional as well as rational decision. I am in a similar position as him, however, for my peace of mind, I want no mortgage....

As many say, there are many ways to skin a cat.

You will probably be fine either way.

I think the main anchor to his rationale is the gold-plated military pension. If that cannot be paid, the environment is very bad and there will probably be much more important issues to deal with than paying your mortgage. The second thing in his favor is the extreme DIY gene he has that drives down his lifestyle costs to probably the lowest possible outside of just going without. It's just lately he has loosened his purse strings....so on offense and defense he has optimized his positions.

If you can do the above, not necessarily as extremely as him, and you can manage any emotional swings, his approach would probably work for you.

[Olemiss540]

Do you plan to use the entirety of the 750k for the retirement house? Do you have SS coming your way eventually and was that accounted for in your retirement simulations?

[unwitting_gulag]

No expert here, or even well-qualified amateur. But my impression is that either route that the OP is mulling, is OK. They don't look starkly different from each other. Here are the key points:

* The OP has had a fine career, with good salary, and is looking at a generous pension.
* The OP has evidently been moving-around, and is not ready and willing to settle down.
* The OP has been frugal and judicious with spending, resulting now in no debt.
* The OP in an unconventional incipient early-retiree, in that a second career is possible, but with large pension, it isn't necessary.

Venturing a guess, the OP is an O-6, yes? If so, there is merit in the much-maligned "one more year" syndrome, because this allows for boosting savings and increasing the pension (to the tune of 2.5% per year). Is this possible? The more years that one has under one's proverbial belt, the more the subsequent options.

The key decision to make, is when to finally retire from the military, whether to embark on a second career, and where to settle down... as opposed to, how to pay for the house that one eventually plans to buy.

[Nords]

Hi Nords!

I've come here to say I will be paying cash for my house which will be finished in Feb. I know Nords from a long time ago....his approach is not for the faint of heart, but his rationale is sound. Nevertheless, for some it is an emotional as well as rational decision. I am in a similar position as him, however, for my peace of mind, I want no mortgage....

I think the main anchor to his rationale is the gold-plated military pension. If that cannot be paid, the environment is very bad and there will probably be much more important issues to deal with than paying your mortgage. The second thing in his favor is the extreme DIY gene he has that drives down his lifestyle costs to probably the lowest possible outside of just going without. It's just lately he has loosened his purse strings....so on offense and defense he has optimized his positions.

If you can do the above, not necessarily as extremely as him, and you can manage any emotional swings, his approach would probably work for you.

Hi, Deserat, good to hear from you again!

And yes, we could play very good defense if necessary. These days our biggest core expense is that mortgage, followed by groceries. We spend far more on discretionary expenses of gifting, philanthropy, and slow travel.

Jim Dahle has good links about leveraging debt from this post, too:
https://www.whitecoatinvestor.com/use-debt-to-your-advantage/
Our leverage is dwindling as the mortgage balance declines, although we're also spending down our investments as well.

[RedSox1]

Nords / Deserat,

Thanks for the follow-up. I admit the SWAN factor, along with an intuitive dislike of paying interest, pushes me towards paying cash and just enjoying retirement. Either way, I appreciate your thoughts and will run the numbers before deciding.

[RedSox1]

Do you plan to use the entirety of the 750k for the retirement house? Do you have SS coming your way eventually and was that accounted for in your retirement simulations?

I plan on using up to $600k of it while using the rest to supplement my pension until I reach 60 and can draw from tax-advantaged accounts. I did account for 70% of projected social security in the simulations.

[RedSox1]

Venturing a guess, the OP is an O-6, yes? If so, there is merit in the much-maligned "one more year" syndrome, because this allows for boosting savings and increasing the pension (to the tune of 2.5% per year). Is this possible? The more years that one has under one's proverbial belt, the more the subsequent options.

Correct and plan to retire with 30 years of service limiting the possibility of increasing the pension. We have winnowed down the "where to live" options and do not want a second career. That said still debating if I will work a few more years to get our youngest through college and test drive a retirement budget.

We have lived below our means over the years and agree that because of that either course of action is viable but feedback from those on this forum is appreciated. Ultimately, COLA adjusted pension is the foundation of our retirement plans that combined with our investing should give us the freedom to enjoy retirement to its fullest while young and healthy enough to do so.

[Olemiss540]

Do you plan to use the entirety of the 750k for the retirement house? Do you have SS coming your way eventually and was that accounted for in your retirement simulations?

I plan on using up to $600k of it while using the rest to supplement my pension until I reach 60 and can draw from tax-advantaged accounts. I did account for 70% of projected social security in the simulations.

Rereading your OP a couple more times, I see no reason to take a mortgage. You are trying to reduce a current tax bill but given your expenses and pension, I don't see any opportunity to greatly reduce this pending tax bill. Given current mortgage rates it makes it even more of a "no brainer".

[Navillus1968]

Active duty military retiring in next 2-3 years and looking for a sanity check on the purchase of "retirement" home. Hoping to get some wisdom from the crowd before paying Facet Wealth or other financial advisor.

We currently have ~$750,000 in taxable accounts that plan to use to purchase a house and support discretionary spending from age 52-60. Will have COLA adjusted pension of ~$120,000 per year starting in 2026 and anticipated annual expenses of ~$131,000-$150,000 (minus a mortgage). This includes ~$85,000-$90,000 of "mandatory expenses" that include taxes and health care. Currently debating whether to pay cash for a house (up to $600,000) or take a mortgage of up to $300,000 at current rates of ~6% resulting in payment of ~$2500/month.
<snip>

Questions
- Does it make sense to pay cash? This would push me into the 24% tax bracket for 2024 given capital gains.

Strictly speaking, adding extra LTCG income does not affect your ordinary income bracket at all, since LTCG always floats on top of OI & is taxed separately.
You will remain in your current 22% marginal rate regardless of how much capital gains you realize. Check out this simple visual calculator for proof- https://engaging-data.com/tax-brackets/

That said, if you realize the full $110k of LTCG in a single tax year while still on active duty, you run the risk of incurring the 3.8% NIIT surtax on LTCG & QDI that is above $250k MAGI. (Note- the Engaging Data calculator linked above ignores the NIIT, unfortunately).
You can eliminate the risk of NIIT by splitting the stock sales into 2 or more chunks in 2023/2024/etc. to keep MAGI below $250k.

- Am I missing anything in my basic assessment of the two options? Is there a better way to fund a home purchase to limit capital gains?
- Is there any reason to consider using ROTH IRA funds to fund home purchase (i.e. lower capital gains paid)? This will be the second house we have bought so not sure can use ROTH to fund.

I have benefited in the past from the wisdom of this forum and appreciate any perspective Bogleheads are willing to share.

How much Roth IRA contributions are left in your & your wife's IRAs after funding the first house?

The 'Rule of 55' applies to TSP accounts, but I suspect you will retire prior to the year you turn 55, so that penalty-free w/d option is moot.

One other option is to do a partial (or whole account) Roth TSP to Roth IRA rollover when you retire. I believe that Roth TSP contributions can then be withdrawn from the Roth IRA as if they were Roth IRA contributions, with no '5-year rule' to satisfy. I think the TSP will transfer a pro-rata mix of your contributions & earnings when you do a rollover, so just make sure you have enough contributions in the rollover to avoid withdrawing any earnings from the IRA. Doing the latter prior to 59.5 will trigger a penalty & taxes.
Here's a thread on the concept- https://forum.mrmoneymustache.com/ask-a ... on-ladder/

If you do the rollover, you should probably put the house money into fixed income in the IRA, rather than stocks, since your time horizon is quite short. A 40% correction during the buying process would be bad if your plan was to sell VTSAX.

PS- Slightly off topic, but you said you don't own any pre-tax funds in your IRA or TSP, but you should check with the TSP to verify this. I think the 5% matching funds for your Roth TSP contributions are placed into a pre-tax Trad TSP account.
2022's SECURE Act 2.0 allows plans to now put matching funds into a Roth account, but I don't think TSP allows this option.

[welderwannabe]

Im a pay cash kind of guy, but I'm not excited about dropping your investments down to almost zero. Once you pay the capital gains on that you will have wiped out your $750K, or close to it to pay cash. How will you find the gap between your $120K pension and your $131-$151K without your taxable account?

I don't think you can afford to pay cash for THAT house, and I wouldn't be excited about going into retirement with a mortgage of any size.

[Navillus1968]

Im a pay cash kind of guy, but I'm not excited about dropping your investments down to almost zero. Once you pay the capital gains on that you will have wiped out your $750K, or close to it to pay cash. How will you find the gap between your $120K pension and your $131-$151K without your taxable account?

I don't think you can afford to pay cash for THAT house, and I wouldn't be excited about going into retirement with a mortgage of any size.

Active duty military retiring in next 2-3 years and looking for a sanity check on the purchase of "retirement" home. Hoping to get some wisdom from the crowd before paying Facet Wealth or other financial advisor.

We currently have ~$750,000 in taxable accounts that plan to use to purchase a house and support discretionary spending from age 52-60. Will have COLA adjusted pension of ~$120,000 per year starting in 2026 and anticipated annual expenses of ~$131,000-$150,000 (minus a mortgage). This includes ~$85,000-$90,000 of "mandatory expenses" that include taxes and health care. Currently debating whether to pay cash for a house (up to $600,000) or take a mortgage of up to $300,000 at current rates of ~6% resulting in payment of ~$2500/month.

OP's house budget is only $600k, $150k of taxable is reserved for roughly 7 year bridge from about age 52 to 59.5, if I'm reading his post right. He should be in good shape.
ETA- OP mentions realizing LTCG of only $75k-$110k, so he must have the bulk of the funds in cash or similar. If OP avoids NIIT, tax on $110k gains is about $16.5k.

[welderwannabe]

ETA- OP mentions realizing LTCG of only $75k-$110k, so he must have the bulk of the funds in cash or similar. If OP avoids NIIT, tax on $110k gains is about $16.5k.

Ahh, I misread it as owing $110K of taxes, not taxes on $100K of gains. My error.

Even then, I still think its tight. He lists up to $30K a year of gap money needed, and needs it for 7.5 years. Thats up to $225K. He mentions adding some funds over the next 2-3 years which will help, but I still feel its tight.

$750K - $16K taxes - $600K house = $134K. Thats not a lot of taxable to be pulling $30K a year out of IMHO.

[ChrisC]

Seems to me that it’s way too early for the OP to have any actionable advice regarding paying cash or taking out a mortgage for a home purchase, since retirement is 2-3 years away and:

1. $750k in current taxable accounts could easily, significantly change in 3 years; could increase to $1 million or decrease to $500k or OP could have capital losses in some other asset to offset capital gains, if any; or could engage in TLH to reduce capital gains taxes;

2. Interest rates could drop significantly in 3 years militating in favor of borrowing, at the same time that equities in taxable or tax advantaged accounts are growing.

When we retired in 2013, with a COLA Federal civilian pension higher than the OP's projected military pension, we took out a modest 30 year mortgage at 3%, which covered half of the purchase price of our home. (We didn’t have to liquidate investments for the balance of the purchase price.) Two years later we refinanced at 2.75%, 15 year term, with no real appreciable increase in monthly payments (as under our initial mortgage we were making additional principal payments). And this is where we now find ourselves. Both before and after taking out our mortgages we had enough funds in cash to pay for our home outright, and it probably made sense to use that then low income earning cash for home financing rather than borrowing even at low rates.

Now it looks pretty good to have cash bearing 5% interest rates in taxable accounts, a mortgage at 2.75%, and equities growing in taxable and tax deferred accounts over the last few years at 8%. Hindsight is great for determining whether past actions made sense, but if you’re going to use the present to predict the future you have to be in the present, not 3 years away from it. BTW, if one does have lots of cash, you can easily buy down interest rates for financing mortgage loans. My son, a veteran but not retired military, was able to buy down his over-sized mortgage loan down to 2% in March 2022 and put up around 30% of the purchase price of his home. And in many counties, if you're a veteran with a 100% disability rating, county real property taxes are waived or not assessed against such veterans -- a real benefit if you're facing high real property taxes.

[USAFperio]

Here are two recent articles by Sam Dogan (Financial Samurai) that provide a few thoughts.

https://www.financialsamurai.com/paying ... ng-stocks/

https://www.financialsamurai.com/the-pe ... y-they-do/