We’re in our early 60s with a few million in the bank – what is the best way to finance our second home in retirement?

24/7 Wall St. Key Takeaways:

• Today, we’ll explore a reader-submitted question about how to purchase a second home: with cash or a mortgage.
• When deciding which option is best for you, consider your tax liability, cash flow, and investment growth potential. 
• Also: Take this quiz to see if you’re on track to retire (Sponsored)

A reader, Frank, recently sent in a question asking for advice about purchasing a $1 million second home in the Southeast. Frank and his wife are semi-retired, debt-free, and considering how to fund the purchase: cash or mortgage?

With over $4.8 million in investments and an annual income of $100k-$200k, the couple is in a solid financial position but wants to avoid large tax liabilities from liquidating assets. The question was primarily how they should fund their next home, not whether or not they could. 

Let’s take a look at Frank’s question and what I would do in his situation. Remember, this is my opinion, not financial advice. 

Key Factors to Consider

When answering this question, there are a few things we need to keep in mind:

1. Tax Implication: Liquidating investments could trigger significant taxes, especially if pulling from tax-deferred accounts like 401(k)s. Capital gains taxes on stocks and mutual funds would also apply. 
2. Preserving Retirement Assets: With retirement already underway, it’s essential to maintain a robust safety net for longevity and market fluctuations. I’m a big fan of preserving retirement savings, as you never know what might happen down the road!
3. Interest Rates & Opportunity Cost: Mortgage interest rates are a key consideration. If they’re lower than your expected investment return, a mortgage may be financially smarter (even if it is technically debt). Paying cash is also an opportunity cost, as that money could be building interest. 

Cash vs. Mortgage

Frank and his wife have two basic options. He could pay cash for the property, liquidating his assets to do so, or he could take out a mortgage. 

Paying cash would allow the couple to take on no debt and reduce expenses in retirement. However, it would create a taxable event now and reduce liquid assets for later purchases. There is an opportunity cost here, too. 

Taking on a mortgage means that they’d have a set payment each month, which forces them to pay interest. However, it also preserves their current assets and opens up the opportunity for them to potentially take tax deductions on the interest. 

My Recommendation

So, what do I recommend? Well, I don’t recommend going all-in on paying in cash or a mortgage. Instead, I would opt for a hybrid strategy that balances liquidity, tax efficiency, and long-term financial health.

1. Combine Partial Cash Payment with a Mortgage: Use part of the taxable brokerage account to fund at least 20% of the purchase price, preventing the need for mortgage insurance. If putting more down would get you a better interest rate, I’d recommend exploring that option, too. This limits the tax hit while reducing the mortgage amount and monthly payments.
2. Leverage Investment Growth: Keep tax-deferred accounts untouched to maximize compounding growth. Ensure enough investments remain liquid for emergencies. 
3. Shop for a Favorable Mortgage Rate: Consider a fixed-rate mortgage to provide predictability in retirement. I’d highly recommend making sure you can comfortably handle monthly payments in retirement, too. Buying a home you cannot afford can cost you millions.
4. Plan for the Tax Impact: Work with a financial planner to minimize the tax impact, possibly spreading sales over multiple years if you aren’t planning on purchasing the home right away.