Retirement income and cash vs. finance of new home

[Terri]

Hello,

I retired in August 2024, so I have 8 months of income.  I am currently purchasing a vacant lot which will close in November 2024.  I want to understand my tax implications for building a home on this lot in 2025.  How do I determine if financing vs. cash payment is the better option?

[Bsch4477]

Your question deals more with financial planning than taxation so you might benefit from advice from a financial planner who would know your entire financial situation. 

[Terri]

Thank for the reply.  It is difficult to explain the situation in this forum.  I am trying to understand the tax implications and what type of tax bracket I would fall into if paying cash for a new home build in 2025 vs. financing over a 30 year period.  I will also be buying health care from the marketplace as I am 62 and not yet eligible for medicare.  So taking out a large sum in 1 year vs. paying a mortgage will also impact my healthcare expenses.  This is why my financial advisor suggested getting input on the tax implications.  

[VolvoGirl]

Not much difference paying cash or taking a loan.  If you finance you might be able to deduct the interest if you itemize deductions along with property tax paid.

For 2024 the standard deduction amounts are:

Single 14,600+1,950 for 65 and over or blind

HOH 21,900 + 1,950 for 65 and over or blind

Joint 29,200 +  1,550 for each 65 and over or blind (both 32,300)

Married filing Separate 14,600 + 1,550 for 65 and over or blind

Oh, where would you get the cash?  If you take a 401K or IRA withdrawal it will probably be taxable and put you into a higher tax bracket and will affect your ACA health insurance.  

[Terri]

yes, exactly my point.  This decision impacts my ACA expense (for 3 years) along with my tax bracket for either 1 big year or 30 consecutive years.  This money would be pulled from a 401k and be taxed.  So, is it better to take this big tax hit in 1 year, then go back to a 'normal' monthly draw from my retirement account or take the continued larger monthly draws to pay a mortgage.

[Opus 17]

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@Terri wrote:

So, is it better to take this big tax hit in 1 year, then go back to a 'normal' monthly draw from my retirement account or take the continued larger monthly draws to pay a mortgage.

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Looking only at that question (and you really should see a financial planner for the big picture) I would consider these factors.

1. What return do you expect on your 401K, compared to the mortgage interest rate?  Your return depends on the risk tolerance of your portfolio and the performance of the economy and the markets.   If you expect a higher return on the 401k than the interest rate you would pay, then you are better off leaving as much money in the 401k as you can.  (And, if you are able to deduct your mortgage interest as an itemized deduction, that reduces the effective interest rate by 12-22%, so a 6.5% mortgage today will actually cost you 5.72%.  Can you make more than that in your 401k?

2. I assume your 401k is diversified and you have a mix of investments with different exposure to market risk.  Your 401k is probably fairly liquid as well, you can get money in a couple of days if you need it.  If you pull money out to make a larger downpayment on a house (or buy it outright), then you have a lot of money tied up in an investment that is not liquid and not diversified.  

Other the other hand, real estate may appreciate more than stocks.  If you can get 7% in the stock market and pay 5% on the mortgage but the house will gain 5% in value each year, then the 401k is -3% instead of +2%;  that would suggest putting more money into the house.  But, it is still not diversified and not liquid.  You would really want to look at buying in a quality neighborhood that holds its value.

[Carl]

This is why my financial advisor suggested getting input on the tax implications.

Just wondering why a financial advisor would suggest getting input from other sources on tax implications. I would expect a financial advisor to be up-to-snuff on that themselves.  Maybe you should be talking with an estate planner or someone well versed with estate taxes/retirement accounts.
If it were me, I'd do a 15 or 30 year mortgage and then consider paying off that mortgage from the retirement account at age 65 to 72.  Remember, at age 71 1/2 you are required to start drawing from an IRA or 401K.  Of course, that would depend on the performance of the account. Overall, I bet an estate/retirement planner could come up with something more advantageous than what I would consider. Especially if your state taxes personal income.

[Mike9241]

you need a different financial advisor. perhaps one that works with a tax or CPA firm. No one can tell you without knowing a lot more about your finances like your source and amount of your annual income. Where would the cash come from? what interest rate are you looking at if you finance and how much? if the cash comes from investments, how much would that be reduced? your taxes are a function of income, deductions, tax credits, additional taxes and filing status. Even then it's still a guess because no one knows what future tax laws might be or the economy.  for example, many changes in the tax laws will expire at the end of 2025. No one knows which might be extended and which will be left to expire.