Retirees today face a number of unique financial challenges, from low-interest rate yields to volatile markets. But perhaps the most significant burden to consider above all is taxes.
With total assets held in IRAs at $7.3 trillion at the end of 2015, designing a strategic income plan to help mitigate the tax consequences of income in retirement is an essential and often neglected part of financial planning today. I refer to this as “TAP,” or tax-advantaged payout, to develop an intentional sequence of withdrawals from financial assets to help keep taxes to a minimum.
One lesser-known tool to consider tapping into for tax-free income is a home equity line of credit on your home. Here are two scenarios in which a home equity line of credit may make sense in your retirement:
Consider an average married retired couple wanting to stay in the 15 percent tax bracket as joint filers. They can take up to $75,300 of taxable income from their IRAs to stay under this threshold in 2016. Then, for any additional funds they may need during the year, they can tap into the home equity line of credit.
If they take $15,000 out, they will actually receive $15,000 tax-free. By comparison, taking the same amount from their IRA would push them into the 25 percent tax bracket, resulting in $3,750 in federal taxes being withheld in addition to any state or local income taxes. Thus, they may only receive roughly $10,000 after taxes from their IRA withdrawal.
Not only is the home equity line of credit tax-free income, the interest is generally low, it is tax deductible, and repayments can be planned over a multi-year term to be covered by future IRA distributions or other investment income. This “TAP” approach spreads out the tax impact to continuously stay under tax bracket thresholds, keeping as much of your money in your hands as possible.
Unexpected expenses come up throughout a lifetime, whether for significant home repairs, health care needs or other costly surprises. If you do not have the funds available in a checking or savings account, don’t let the emotion of a stressful emergency drive you to making impulsive (and costly) financial decisions.
Rather than turning to a high-interest credit card or cashing out investments at an inopportune time in the market, a home equity line of credit can be a smart choice. This can give your financial adviser time to plan an exit strategy rather than rushing to liquidate securities. This also allows time to design a repayment plan that maximizes both tax and investment advantages to your favor.
As a bonus savings opportunity, if you are considering purchasing a new home or refinancing an existing home, you may consider setting up a home equity line of credit at the same time. Many banks will offer a discounted or “free” home equity line of credit closing, making it an even more cost-effective tool to consider.
While there are other ways to leverage the equity of your home to create cash flow in retirement, a home equity line of credit will often be most desirable for retirees based on its flexibility for scenarios such as future downsizing or potential need for assisted living facilities in the future.
In short, a home equity line of credit can be a powerful tool as a part of a proactive and comprehensive cash flow plan in retirement.
Pete Lang is a retirement, investment and tax specialist, and the founder and president of Lang Capital, a private wealth management firm with offices in Bluffton and in Charlotte. For more information, go to www.langcapital.net or call 843-757-9400.