Ask an advisor: Can my client afford to build her retirement dream home?

February 8, 2024 5:35 PM

A California retiree dreams of building a residence on her son's property. But could she afford it?

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

Downsizing one's home is a common way to save money during retirement. Sixty-four percent of American seniors move at least once after they retire, according to a study by Merrill Lynch. Of those who do, about half move to a smaller house.

But buying a home — even a smaller one — is not easy in today's economy. Housing prices have risen by 47% in the past 10 years, according to Federal Reserve data. Meanwhile, as interest rates have increased, mortgages have jumped to their highest levels in two decades.

But what if you had the chance not to buy a home, but to build one? An older woman in California believes she has enough savings to construct a small residence on her son's property. In her view, this would not only reduce her housing costs, but could also help her and her son care for her husband, whose health is deteriorating.

Guiding her through her options is her financial advisor: Ralph Roy Ramirez, founder of Ramirez Financial Services in Yucaipa, California. But Ramirez sees an obstacle to her dream: the U.S. tax code. For help, he turned to his fellow wealth managers for advice. Here's what he wrote:

Dear advisors,

I'm a financial advisor in Yucaipa, California, and I could use some help guiding one of my clients through a complicated transition.

My client is an 81-year-old California woman who wants to downsize her home. She is in good health and very active, but her husband has dementia and requires full-time home health care. To save money and accommodate her husband, her plan is to move into an additional dwelling unit (ADU), which would be built to the rear of her son's property.

To pay for this, she has about $300,000 saved up in two IRAs and two 457 deferred compensation plans. But here's the rub: This money could cover the construction, but not the taxes she would have to pay for making the withdrawals.

Is there any way around this? I know there are favorable tax treatments available for emergency expenses. What about for the construction of an ADU and home health care? Can you guide me?

Thank you,

Ralph Roy Ramirez

And here's what financial advisors wrote back:

Bad idea

Kashif Ahmed, certified financial planner and president of

American Private Wealth

in Bedford, Massachusetts

OK, so you are going to take all of her retirement money to construct this new space, but then there is apparently no money left to not just pay the taxes due, but also money to maintain the place, pay all the other bills and buy groceries. This does not sound like a prudent plan of action.

Of course, there is no indication of what proceeds she may have available once her existing home is sold, or what other funds are available for her. Either way, to use up all of her retirement assets doesn't seem prudent, given that she seems to be active and in good health herself, i.e., will still have many more years to live, and pay for.

Pace yourself

Noah Damsky, chartered financial analyst and principal at

Marina Wealth Advisors

in Los Angeles

Slower IRA distributions over a longer period of time can impact her tax hit by allowing her to stay in lower tax brackets annually, as compared to taking the money out in large chunks to pay for construction expenses. If they can get a loan to pay for the ADU (refinancing if she rents her old home, or a personal loan), that could enable her to spread the IRA distributions over several years.

On the other hand, this may not be a suitable strategy because predicting construction costs can be difficult. The project often costs more than expected, and with a tight budget, there might not be enough cushion. If the value of the completed property is a consideration, ADUs are known for not holding value as a result of high construction costs and the property not appraising as a traditional duplex.

Distributions for emergency expenses can be helpful for small emergencies, but the dollar value limits will be prohibitive in this situation. If you're committed to this path of an ADU, then obtaining financing to allow her to spread distributions over several years may be the best path to lower taxes.

More to think about

Jay Zigmont, CFP and founder of

Childfree Wealth

in Mount Juliet, Tennessee

If all they have is $300,000 left, I would be very reluctant to spend that on an ADU. The building is the start of long-term care costs, not the end. With Alzheimer's, you need a plan for the progression of care, including 24/7 locked care if needed. An ADU will most likely be considered housing, not health care. While it may be possible to get a loan or mortgage for the build of the ADU, which will help with the current tax issue, the overall costs for long-term care will not be addressed.

The other consideration is to make sure that the husband's medical needs do not overwhelm the wife's own long-term needs. There isn't a great answer overall, but I would be very reluctant to put everything into an ADU, even if the taxes can be covered.

Talk to a lawyer

Ron Strobel, CFP and founder of

Retire Sensibly

in Meridian, Idaho

If I'm reading this correctly, the client is planning to deplete her entire nest egg to build this ADU. Is there an existing home she will be selling to replenish her savings? If not, this seems like a risky proposition to me. How will she be paying for the in-home health care? What if her husband needs to enter an even more expensive care facility? What if she has her own long-term care needs?

My first recommendation with cases like this is to involve an experienced elder care attorney, especially before investing all of the client's assets into a structure on someone else's land. Once they draft a plan to pay for the medical care and any potential Medicaid or other complications, then it will become more clear what the right move is. As it stands right now, it simply doesn't seem like the client can afford this new construction project.