We’re a retired couple living comfortably on our pension and Social Security. We don’t need our investments for living expenses, and have no outstanding debts. We’re looking to sell our house and purchase a new home in an adult community for about $200,000 more than we expect from selling the old one. Does it make more sense to obtain a mortgage or to withdraw the money from investments? What are the tax consequences?
You’re lucky to have such an upbeat problem, but you’re right that it isn’t a no-brainer. There are many issues to consider — ideally, with the help of a tax professional and/or financial planner who can discuss hypothetical future scenarios and crunch numbers for you.
If you withdraw $200,000 from a tax-deferred account like an IRA or a 401(k) plan, the entire amount is taxable as ordinary income, says Ron Rogé, a Bohemia financial planner. If you withdraw $200,000 from a taxable account, the tax bill depends on how much of it represents embedded capital gains. Either way, the withdrawal could push you into a higher tax bracket for the year. And two years later, it could mean a higher health insurance bill because annual Medicare premiums are based on the income reported on your tax return two years earlier.
But a mortgage isn’t cost-free, either. Long Islanders pay a 1.05 percent mortgage recording tax, and closing costs can be substantial. (Lenders must give you an estimate.) “There’s also a cash flow issue to consider,” says Rogé. “A 30-year loan at 3.5 percent costs almost $900 a month. Will your Social Security and pension income cover that additional expense? And if one of you dies, will the survivor be able to afford the mortgage payments?”
THE BOTTOM LINE Before making major financial decisions, consider all the potential future results.