Should my wife and I deplete our cash reserves, withdraw from my 401(k), or use a HELOC to finance home improvements?

I am a 61 year old retired married man. My pension is $3,723 per month. I plan to start collecting Social Security ($2,048 a month before taxes) at age 62. I have $300,000 in a 401(k) account which is invested in a fixed-interest fund. My wife is 51 years old and will retire in nine years with a pension of approximately $3,460 per month. She will have approximately $900,000 in her 401(k) at retirement and plans to collect a similar amount of Social Security at age 62.

We borrowed $115,000 from a relative to purchase a house worth $265,000 and are in the process of securing a mortgage to pay it back. We are currently debating the length of the mortgage (input on this would be appreciated). We plan on updating and improving the house over the course of the next two to three years and plan to spend around $80,000. We have no other outstanding debt and have $70,000 in cash and a vacant lot currently for sale worth $85,000 as our only liquid assets. Should we deplete our cash reserves, withdraw from my 401(k), or use a HELOC to finance home improvements?

Co-Published on Investopedia

Co-Published on Investopedia

Congratulations on being set up so well for retirement. I'll answer your question first, but I also want to offer some additional advice which will be important to your long-term financial security. I would be hesitant to pay for the home improvement either through withdrawing from either retirement account or getting a HELOC. Both options will increase your risk and harm your ability to enjoy a comfortable retirement over the long-term. 

If you can wait on the home improvements, using the proceeds from the sale of the vacant lot is likely going to be a better option. This preserves your retirement accounts, avoids unnecessary taxes, and leaves you with plenty of cash for an emergency fund. Another option would be to get a first mortgage of $195,000 instead of $115,000. You would then have enough money to pay your relative back, and another $80,000 for the home improvements. Because you will still be well above 20% equity in the home, you will avoid primary mortgage insurance. This reduces the interest costs verses the HELOC and will provide a fixed interest rate.

Consider a 30-Year Mortgage

For the mortgage term, I generally recommend a 30-year mortgage. The payments will be smaller, which will allow you to avoid drawing down your retirement funds (and paying extra taxes) just to pay a low-interest loan. Because you and your wife's pension income far exceed the mortgage payment, you shouldn't have trouble making a mortgage payment for the next 30 years. Conversely, a 15-year mortgage will have a much higher payment and will reduce your income during the early part of your retirement when you will be most healthy and able to enjoy the money.

Consider Waiting on Social Security

I also recommend talking with a financial adviser before you and your wife collect Social Security. Based on the information you provided, you don't need to take Social Security at age 62. Depending on your health and other factors, waiting to claim Social Security until a later age could significantly increase your retirement income. Waiting until age 70, for example, would increase your Social Security checks to approximately $3,600. Over a 30-year retirement, this difference would be hundreds of thousands of dollars. 

A good financial planner can run the numbers of your retirement income over a 30-year retirement to show you how the different retirement options play out mathematically. Then you can make a more informed decision.

Joshua Escalante Troesh is the President of Purposeful Strategic Partners and a tenured professor of Business at El Camino College. To explore working with him on your personal financial planning and investment advising needs, simply schedule a free Discover Meeting.

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