How big a home can you afford in retirement?
Size up your 401(k) and sharpen your pencil; there's math involved
By Gary Foreman
The New Frugal You
Dear New Frugal You,
I'm retiring at age 63+ (health problems) and I'm also getting a divorce. I'm taking the 401(k) and she'll take the house (about equal value). Keeping most of the money in the 401(k), how can I buy a house -- $100,000 or up to $150,000 -- and live on Social Security and the 401(k)? -- Tim
Sorry to hear about your health issues and pending divorce.
You didn't provide information about what you expect your Social Security
benefits to be or what your 401(k) is worth so we'll have to make some
assumptions to illustrate. You can fill in the real numbers and calculate to
get your official answer.
I assumed that your recent income was $60,000 per year.
That's important because it affects how much Social Security you'll receive. I
also assumed that you'd begin receiving your Social Security benefits now, as
opposed to delaying them until you're 65.
Based on that income and retirement date, you'll receive
$1,562 per month or $18,743 per year from Social Security. You can find a
calculator to estimate your Social Security benefits at
the Social Security Adminstration's website. You can also contact Social Security at (800) 772-1213 and ask for form SSA-1099.
How much money you can take from your 401(k) plan will
largely depend on what assumptions you make. Some financial planners will
gradually consume your principal along with the income earned. Their goal is to
zero out the account about the time you die. The danger in that is that each
year you have less principal to earn money. Therefore you consume more
principal every year. You could outlive your principal.
A more cautious approach would be to just spend the money
that your 401(k) earns each year and not consume any principal. Again, we're
faced with making assumptions to determine how much your 401(k) principal will
earn each year. In the real world, you can limit yourself to taking the actual
earnings. But, for now we need to estimate what those earnings will be.
Let's be relatively conservative and assume that your 401(k)
will earn 5 percent per year. So for every $1,000 in principal you can plan on
taking out $50 per year. Of course the IRS will want its share, so reduce that
by your tax rate to determine what you will really have to spend.
A point to remember: After age 70 1/2 you'll need to take
"required minimum distributions" from your 401(k). It's an IRS
requirement and will affect your taxable income. But, just because you're
required to take money out of your 401(k) plan, that doesn't mean that you're
required to spend it. You can reinvest it outside the 401(k) and continue to
just spend the earnings.
So how much income will you have? We'll assume that Social
Security and your 401(k) are your only sources of income. And, that your 401(k)
is worth $100,000 after you take a portion for the house down payment.
That would mean $1,562 from Social Security plus another
$333 from the 401(k). So a total of $1,895 per month.
How much will the house cost you? Again, let's make some
assumptions. We'll say that you buy a home that requires a $125,000 mortgage
and that you get a 30-year fixed mortgage at 5 percent interest. That would
mean a payment of $671 per month.
You can do your own calculation with real numbers with the mortgage calculator on the
It's important that you keep your housing expense to less
than 35 percent of your spendable income. So you shouldn't spend more than $663
per month ($1,895 x 35 percent) on housing.
Your mortgage payment alone is greater than that. Plus, we
haven't factored in utilities, insurance, maintenance and property taxes. All
of those expenses should be part of the 35 percent.
If our assumptions were accurate, you'd need to revise your
plan. Perhaps you need a less expensive home (condo?) or a plan that included
sharing the home with a renter.
It's important to work through the finances before you make
any financial commitments. Buying a home and then struggling with the payments
won't make for a comfortable retirement. Better to work through the math now
and adjust your expectations to avoid trouble later.
See related: Tips for living with a roommate, Retirement in sight? Balance your risk tolerance, need for growth
For more than 35 years, Gary Foreman has worked to help people get the most for their money. Prior to founding The Dollar Stretcher.com, he was a financial planner and purchasing manager. Gary began The Dollar Stretcher website and newsletters in April 1996. Today the website features more than 6,000 articles on different ways to live better for less. Gary has been interviewed by The Wall Street Journal, The Nightly Business Report, USA Today, Reader's Digest and other newspapers and magazines. Gary answers a question about a budgeting or saving issue from a CreditCards.com reader each week.
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Published: January 27, 2011