Preparation Can Make A 2nd Home Possible

By Martha M. Hamilton
Sunday, September 23, 2007

Like many people approaching retirement, Kathryn Scruggs and her husband dream of a second home in which to spend leisure time. Her dream is a house in Lake of the Woods on a 550-acre lake in Orange County, Va., only about an hour and 15 minutes from her home in Arlington.

Scruggs grew up in Chicago and relishes swimming in cool, clear lake water. "I just went down to Rehoboth for the weekend, and I thought, no, I'm not a beach person. I'm a lake person." Retired from 29 years teaching in Arlington public schools and with her husband's retirement only about a year away, she has her eye on an old waterfront rambler.

"Can we seriously consider buying a lake house?" she said.

In her case, the answer is yes, said Christopher N. Brown, president of Ivy League Financial Advisors in Rockville. But others dreaming of a second home may not be as lucky, he said.

Scruggs and her husband, Max, a federal employee, are better prepared for retirement than most of us are. Three key factors make the difference, said Brown. For one thing, Scruggs and her husband both have traditional pensions that provide them with monthly income for life (and retiree health-care coverage). In addition, they have a modest lifestyle and substantial savings.

Brown said he starts his analysis of whether clients can afford their retirement dreams by determining if they will outlive their money. "If your retirement is not in good shape, we can stop the analysis here. If it is, we can go forward."

In the case of Scruggs and her husband, the expenses are modest enough that, even without savings, the two would be in good shape.

Their annual expenses are about $80,000, including everything but the $20,000 home-equity line they have. (The home is paid off.) And their savings are about $600,000. When Brown ran the numbers -- assuming they both live into their late 90s and assuming investment returns of 6 percent for the taxable accounts and 8 percent for the tax-deferred accounts -- they came up aces.

Even when Brown tinkered with the numbers, reducing anticipated returns on investment and increasing expenses, the outlook was good. "The only scenario we ran where you ran out of money was when we added $60,000 in annual expenses each year," he said. "In this case, you ran out of money when you were both 94."

Because the pensions provide guaranteed income -- together their pensions add up to more than their annual expenditures -- they can use money from savings for something other than the basics.

They have their eye on houses with an asking price of about $450,000, said Scruggs. Brown assumed that they would put 20 percent, or $90,000, down and finance the rest at 6.5 percent. He also assumed that they would invest $25,000 to refurbish it and pay about $5,000 a year in property tax and about $1,000 a year in insurance. On top of that, they would have maintenance and homeowners association fees of about $3,000 a year.

Scruggs wanted to know if it made sense to put even more money down, to which Brown said no. He said it was important to get the amount financed below $417,000 to avoid the difficulties currently associated with jumbo mortgages. Beyond that, given the tax deductibility of mortgage interest and the current rates, they would probably earn more by leaving their money in investments than they would avoid in interest payments, he said.

He also suggested a strategy for withdrawing the money to buy the house that would minimize taxes. First, he said, they should draw the money out of their taxable savings and mutual funds, not their tax-deferred funds, for most of the down payment. Taxes on money withdrawn from those funds (which were enough to cover most of the suggested down payment of $90,000) will be taxed at the lower capital gains rate of 15 percent or less, whereas money withdrawn from their tax deferred accounts would be taxed as income. Since Max Scruggs is still working, that rate would be higher.

So congrats to the Scruggs family, who seem within reach of their retirement dream. But what about the rest of us, and what lessons should we draw?

¿ It's important to pay attention to benefits such as traditional pensions and retiree health insurance when you're deciding which job to take.

¿ Save early and often.

¿ When you're considering an expenditure like a second home, take into account all the associated expenditures such as travel to and from, maintenance, property taxes and furnishings.

Most people are lucky if they have any one of the three things that Kathryn and Max Scruggs have going for them -- pensions, a modest lifestyle and substantial savings, Brown said. The couple would have needed massive -- possibly unobtainable -- amounts of savings to be able to afford the second home, absent the pensions.

It would take about $2.3 million in savings to replace the $116,000 in annual pension income the Scruggs will receive, said Brown. If not for that guaranteed income, it would be "game over," he said. "Most people don't have that luxury."

Join Martha Hamilton and Christopher N. Brown of Ivy League Financial Advisors for an online chat athttp://washingtonpost.comat noon on Tuesday.

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