Is It Smart For American Electric Power Employees to Withdraw From Their 401(k)'s to Buy a Home?

At the crossroads of American Electric Power retirement, the questions of how to judiciously allocate your resources to ensure a comfortable life become more pertinent. One such scenario has come to light where a gentleman poised to retire contemplates relocating to Georgia. Armed with $350,000 in savings, $500,000 in a 401(k), and the prospect of $3,000 monthly from Social Security, he assesses his options.

His plan: purchasing a $450,000 condo in Georgia using $350,000 from savings and $100,000 from his 401(k). He further contemplates withdrawing an additional $20,000 from the 401(k) as an emergency reserve. Such an arrangement will retain $380,000 in investments, potentially yielding about $15,000 a year based on a 4% annual withdrawal. This, coupled with his Social Security income, is projected to cater to his living expenses, vacations, and major purchases.

The central question is whether investing and renting is more lucrative than buying a home outright.

For many, the allure of home ownership stems from circumventing escalating rents. Yet, the decision isn't black and white. A preliminary glance reveals that while buying the condo necessitates a monthly outlay of roughly $1,000 for taxes and fees, renting a similar property would cost approximately $2,500.

A notable consideration for American Electric Power retirees is the long-term value of homeownership in the context of estate planning. According to a study published by the National Association of Home Builders in June 2021, homeownership can significantly boost an individual's net worth, and homes account for a significant percentage of the assets of U.S. households aged 65 and older. As such, purchasing a home might not just provide a place to live but can also be a strategic asset in terms of legacy planning and passing wealth to the next generation

Consulting with certified financial planners (CFPs) lends greater insight to American Electric Power employees approaching retirement. Sandra Gilpatrick, a seasoned CFP from Boston, notes that the proposed investment, i.e., the condo, would yield roughly a 4% return on savings. If the gentleman were to keep the assets invested with an allocation of 60% fixed income and 40% equity, a 7% annual return could be more plausible. Gilpatrick also underscores the unforeseen expenses linked with homeownership, which individuals often overlook. Fluctuating housing-association fees, property-tax hikes, special assessments, and real estate transaction costs are some key concerns. Moreover, leveraging the 401(k) might propel the individual to a steeper tax bracket, potentially rendering him liable for the Medicare surcharge - the IRMAA.

Jamie Bosse, another CFP from Kansas, concurs, emphasizing the tax implications. Extracting $120,000 from a 401(k) doesn't translate to the full amount, post-tax deductions. At a combined federal and state tax rate of 27%, the net amount dwindles to approximately $87,600.

Advisors typically suggest renting initially upon relocating, ensuring that the new environment aligns with one's preferences before a hefty financial commitment. Additionally, by buying the condo, over half of the gentleman's assets are tied up, thus curbing liquidity.

A macroeconomic lens further cautions against hasty real estate ventures. Notably, U.S. home prices have surged roughly 50% pre-pandemic, even with rising mortgage rates. The Federal Reserve Bank of Atlanta indicates that housing affordability is currently mirroring the lows of 2007, preceding the most debilitating real estate downturn since the Great Depression. Both nationally and specifically in Atlanta, there's an undeniable risk.

Featured Video

Articles you may find interesting:

In contrast, if invested wisely, the funds could secure consistent returns. As of now, ten-year U.S. Treasurys are yielding 4.3%. Short-term municipal bonds, such as the iShares Short-Term National Muni Bond, offer a tax-free 3% yield with marginal risk. Long-term municipal bonds, like the iShares National Muni Bond ETF, are yielding 3.4% tax-free, and the Schwab U.S. REIT ETF provides a 4% yield.

The financial landscapes of American Electric Power workers vary, interwoven with myriad factors. Yet, given the current circumstances, renting initially appears to be the more sagacious choice, ensuring liquidity and diversified investment opportunities.

Deciding whether to use your 401(k) to buy a home during retirement is akin to a seasoned chess player contemplating a crucial endgame move. Both situations require forecasting the long-term repercussions of an immediate decision. Just as sacrificing a powerful chess piece might grant temporary control over the board but jeopardize a future checkmate, using American Electric Power retirement funds for a home might offer present comfort, but could also risk one's financial stability in the later stages of the game. It's essential to consider all angles, potential threats, and the evolving landscape before making the final move.