Friday, April 1, 2011

Should You Count Your Home As a Retirement Asset?

Recently, I received in the mail a letter from Consumer Reports touting their Money Advisor newsletter.  This is their "mini-magazine" that is dedicated solely to articles and advice on money matters written in Consumer Reports' trademark no-nonsense style.  On the envelope were a number of "key questions to ask yourself now":

1. True or False:  If you retire with $400,000 in savings, you can safely withdraw up to $24,000 a year and avoid running out of money.

2. True of False:  You should never count your house as a retirement asset.

3. True or False:  38% of Americans who run out of money cite health care costs as the #1 cause.

The envelope proclaims that the answers are inside (cheap tactic of theirs to get you to read the contents).  However, you only have to keep reading to get the answers for yourself (cheaper tactic of mine to get you to keep reading this article)...

1. False.  If you retire with $400,000 in savings, you can safely withdraw only up to $16,000 a year.  If you end up taking out more than about 4% of your principal per year, you could be in serious danger of running out of money.

I agree.  This is the standard rule-of-thumb for setting your withdrawal amount in retirement.

2. True.  When you're totaling up your retirement assets, you should leave your house out of the calculations.  In today's world of booms and busts, it's unwise for pre-retirees to bet the ranch on their home value.

I disagree, but more on this later.

3. False.  About 50% of those who filed for personal bankruptcy in a recent study cited medical bills or illness as a reason.

I had said True originally.  Didn't realize that it was going to be higher!

Anyway, the one with which I had the most trouble was #2.  I understand that recent events seem to indicate that you can't count on the value of your home being stable.  However, the same can be said for stocks or bonds, which make up a large proportion of anybody's retirement fund.  You wouldn't say that you shouldn't include stocks in your retirement assets just because they can drop 30-40% in a single year, would you?

That being said, I do concede that your home's value should be treated differently than a stock or a bond when planning for retirement.  A home is not just an investment; it is a place to live.  You can sell a stock and that's that.  Selling a home isn't quite so simple.  If you sell your home, you have no place to live!  You have to buy or rent something else unless you plan on living under a bridge or something.  Therefore, some of the proceeds of the sale of your house need towards something.  That requires some forethought as to what you would do if you plan on using some of your home's value to supplement your retirement savings.

There are a couple of possibilities:

1. Continue to live in your existing home in retirement.  If you plan on doing this, you aren't going to be able to tap into your home's value to fund your retirement.  Therefore, you should exclude it from your retirement savings.

2. Continue to live in your existing home in retirement and take out a reverse mortgage.  A reverse mortgage is a financial arrangement where a bank agrees to loan you some percentage of your home's value while you are still living there.  Unlike a typical mortgage, however, you don't have to make a monthly payment.  Instead, when you die or decide to move, the bank takes ownership of your home in order to pay back the debt.  This arrangement allows you to access your home's value in retirement while giving you the ability to stay in your house.  Reverse mortgages are known to have lots of fees, though, so you may not get full value for your house.  If you plan on this sort of arrangement, you can include some percentage of your home's value in your retirement assets.  However, you probably want to be conservative in your valuation account for the volatility of the real estate market as well as the fees involved with this sort of arrangement.

3. Move to a smaller home.  In retirement, you probably don't need as big of a home as you did when you had children in the house.  Therefore, moving to a smaller, cheaper home is another way to access your home's value in retirement.  Obviously, you won't be able to access your home's entire value because you need to use some of the proceeds to purchase your retirement abode.  However, assuming your new home is smaller, you should be able to pocket some of the proceeds.  This assumes that your mortgage is paid off (which it should be if you are planning to retire).  One good thing about this plan is that if the value of real estate goes down, this will make buying your retirement home even cheaper.  Trading down likely will allow you to pocket at least some of your home's value.  Again, be conservative in how much you think you might get because you will need to take into account all of the various transaction costs (broker fees, taxes, moving costs, etc).

4. Sell your house and rent.  This strategy allows you to access the full value of your house up front.  However, now you will have to factor in your monthly rent payment into your retirement budget.  One good thing about this arrangement is that you don't have to lay out money for housing all in one shot like you would if you bought a retirement home.  The proceeds of your home sale can sit in the bank, earning interest as you withdraw it in dribs and drabs every month for rent.

As you can see, there are various approaches to incorporating the value of your home into your retirement planning. As with all retirement assets, real estate values fluxuate, but that doesn't mean that you shouldn't exclude it from your retirement planning completely.

1 comment:

  1. Nice article. When someone thinking about the retirement or financial planning its desired to say that they really liked your blog and posts. Keep continue...