Share this Post
Should a FERS Retiree Buy a House in Retirement
It’s not uncommon for a federal employee to retire and buy a house later. I have consulted on this topic three times in just the past few weeks. The biggest question retirees have is if they should take the funds out of Thrift Savings Plan (TSP) to pay for the house.
The answer to that question is almost always a big fat N-O! Buying a house for 300K-400k would require a substantial distribution from TSP—a distribution well north of the purchase price—to account for the taxes that would have to be paid. So, the simple answer to this query is no, but there are other questions to consider.
1. Is it a good idea to buy a house in retirement?
2. How do I pay for the house?
3. Should I have a mortgage payment in retirement?
To be clear, I’m talking about a retiree who doesn’t currently own a home or who is considering buying a second home. Buying a home in retirement isn’t an ideal situation, but it can be done. It would be ideal to purchase the home before a person retires and still has a salary from employment, but sometimes circumstances don’t allow this to occur.
Regarding the third question—yes, it is possible, and many people do it. A retiree can plan for this additional payment and treat it as a monthly expense in retirement. Before jumping into a 15 or 30-year mortgage, please make sure your cash flow can handle the additional monthly expense. If you find that the additional monthly expense is too high and there is a high risk of running out of money in retirement, then you probably shouldn’t buy the home.
A 20% down payment is generally necessary to purchase a home. Where should that 20% come from? It would work best if that money came from a combination of taxable accounts, such as:
- Checking accounts
- Savings accounts
- Brokerage accounts
These accounts are ideal because the tax impact of taking proceeds from them would be low. For example, taking money out of the first three accounts wouldn’t have any tax impact because the interest is taxed annually. The brokerage account could have capital gains, but those gains should be significantly lower than paying income tax on the whole distribution, which would be the case with TSP. This is another good reason for working feds to save/invest money in different types of accounts.
What if a federal employee retires with just an account for emergency savings and their TSP?
I’ve encountered this tricky scenario multiple times lately. Let’s use an example of a married couple, both of whom are 54 years old and one is a retired law enforcement officer (LEO), buying a house for $300,000. The required down payment for the house is $60,000, there are $30,000 of other house-related costs, and the mortgage rate is 6.5% for 15 years. Most of their spending needs are met by their FERS annuity and supplement. The couple has the following accounts and incomes:
- Savings account—$70,000
- FERS Annuity—$4,500 month
- FERS Supplement—$1,200/month
Just for fun, let’s look at what it would take for this couple to pay for the entire home with cash. They would like to leave $40,000 in savings, so they will need to cover the other $260,000 from their TSP. To net $260,000, they will need to take a distribution of around $335,000, costing them around $75,000 in income taxes. In other words, this is not the best idea, so we’ll move on to the next scenario.
This next scenario is a perfect example of why you always leave some money in your TSP if you are retired and under the age of 59½. This retiree would have a penalty for accessing an IRA prior to age 59½ but not so with TSP. Also, as long as the TSP stays open, money could be moved back into TSP for better access.
Since part of the needed $90,000 (down payment plus the other house-related costs) is going to have to come from TSP, we must figure out what their taxable income is. Their total income is $68,400, and the standard deduction is $27,700, which gives them a taxable income of $40,700. The 12% tax bracket goes up to $89,450, so they can take $48,750 out of their TSP and only pay 12% in federal income tax. Keep in mind that this does not include state income tax, which varies greatly from state to state. Some states don’t have an income tax; some states don’t tax retirement income while other states do.
An ideal plan for this couple would be to take a $48,750 distribution from their TSP and take the rest from their savings account. If they want to replenish their savings account, they could do that in 2024 and still pay 12% in federal income tax.
Because their mortgage rate is 6.5%, they plan to aggressively pay down the mortgage until it is either paid off or they can refinance to a lower rate. They plan to do this strategically by taking distributions from their TSP while staying in the 12% income tax bracket.
If this is something that you are considering, please consider the opportunity cost of the money you are taking out of your investments. Most people save money in their TSP and long-term investments with a goal of providing income in retirement, and every dollar taken out of those accounts will reduce future income. In the scenario above, the couple was living comfortably on their guaranteed income streams of the FERS annuity and FERS supplement; therefore, they were comfortable drawing from their TSP to purchase the home.
Buying a home in retirement is similar to many financial topics—it can be done, depending on the circumstances, with a well-thought-out plan. If you would like help with topics like this on your retirement journey, you can schedule an introductory call with me to discuss your financial concerns, learn more about me, and see if we are a good fit to work together.