Author: Douglas Gross, CFP®
Many people consider looking for a new home in their 50’s. They may be looking to downsize, have a job transfer to another city, desire a warmer climate, want to be closer to grandchildren, or are just looking for a change. Financial decisions are always important, but maybe even more so in your 50's as retirement nears and becomes a bigger part of the conversation.
It is important to frame your home purchase around your goals. Earlier in life, choices generally revolved around schools, proximity to work, and a home design suitable to meet the needs of a growing family. Now the choice is more personal. Does the home provide easy access to activities, grocery stores, walking trails, or local clubs? Does the home have multiple floors or other design features that become more difficult to navigate with age? What about living space for visiting family or entertaining? Every situation is different but you want to be sure the home fits your lifestyle and financial capabilities going forward.
How are you currently positioned for retirement?
Retirement income planning is becoming more and more important. Retirees are facing higher healthcare costs, longer life expectancies, and uncertainty around the future of Social Security. Most do not have pensions. And many do not work with a financial advisor. The purchase of a new home is an important milestone and probably deserves a second opinion. Here’s why:
Let’s say your previous house cost around $500,000. There is a natural tendency to spend the same amount (or more) on the replacement home. Most peers are in homes of similar value and no one wants to look less prosperous than others, especially after working so hard to reach financial success. This “keeping up with appearances” is a real challenge for most of us. Many of us justify that more expensive home with the idea that it will appreciate in value and so there is no net additional cost. For most of us some of these expenses operate as “hidden” costs. Money in, money out. But in retirement we are generally working from a fixed pool of investment assets. The extra $20,000 or $30,000 per year in expenses really add up over time.
Table 1: Expense comparison - $300,000 home vs. $500,000 home
|Annual maintenance, 3%||$9,000||$15,000|
Mortgage Payments, 15 year, 3.92%
|Heating and cooling||$3,000||$5,000|
|Snow removal and lawn care||$1,500||$2,000|
|Mortgage Principal payments||$992||$2,724|
|Net Cost after Principal payments||$28,340||$57,260|
|Excess Cost of larger home||$28,920|
|Tax Benefit of taxes and interest (Table 2)||$3,821|
|Net Additional Annual Cost||$25,099|
This Chart is for illustration purposes only
If the home appreciates (like most homes) at the rate of inflation, doesn’t that work out? Well, if you spent $200,000 more, and that value inflated at 3% a year, that is $6,000 a year of added value. But if you are paying 3.92% interest (current rate for 15-year loan) your interest costs are $8,832 a year – so you actually pay more in interest every year than you gain in appreciation.
When you think of the home as an investment and appreciating asset, you need to really understand these costs. If the $500,000 home appreciated at 10% a year (a very rare event for any multi-year scenario) it is appreciating $50,000 in your first year of ownership, a wonderful outcome. But with your home ownership costs being about $55,000 a year, you are net down by $5,000 a year!
Changes to itemized deductions, beginning in 2018, significantly reduced the tax benefits of home ownership. With the deduction for state and local taxes capped at $10,000, the additional costs of a more expensive home will often yield no tax benefit. Here is an example.
Table 2: Tax Comparison
|Deduction||$300,000 Home||$500,000 Home|
|State income taxes on wages||$8,000||$8,000|
|Deduction capped at $10,000||$10,000||$10,000|
|Tax benefit at 24%||$3,821|
This Chart is for illustration purposes only
If you are in your 50’s and saving for retirement, the extra costs of the $500,000 home really add up. You are not able to save $25,000 a year and many of these extra home costs will extend all the way through retirement. (And who in their 50’s is not saving for retirement?)
What if you saved $25,099 a year instead of experiencing higher home costs? With a modest 6% rate of return you will accumulate $608,062 from 50 to 65. This much money gives you another $24,322 if you spend 4% a year of it every year in retirement, a really significant amount. If you add that to the extra annual $25,099 in costs you are avoiding in the less expensive home you have an income swing of $49,421 annually.
Worst case scenarios
Unfortunately, people rarely assess the risk that their job may be terminated in their late 50’s, yet it is more frequent now. Companies looking to cut costs lay off 55-60-year-old employees with amazing regularity. If you have stretched, bought perhaps more home than you can afford, and now lose your job, you will almost inevitably have to use your savings or move. Your stress is compounded by the fact that during a period where you were trying to maximize your savings you have in fact been saving less due to the high cost of your home.
The other risk is that home prices decline and you need to sell. Prior to 2008, many Americans believed it was very rare for home prices to decline. 2008 changed that belief, and many homes are just now getting back to 2008 prices, 10 years later.
Best case scenarios
Occasionally people have the good fortune to buy this $500,000 home in San Francisco and it turns into a $1,500,000 home – what a windfall! It is much more likely that your home will appreciate at 2-3% a year, essentially the rate of inflation. This gain is much less than the expected returns on stocks or even a balanced portfolio of stocks and bonds.
How do I decide what is right for me? If you live on the coasts, your choices may be very difficult. Housing is just expensive and a $300,000 home may not be available anywhere you would want to live. For many of us however, this is a realistic choice in home spending. If you are wealthy all this discussion may not make much difference, live where you want. (I’m referring to individuals with $4,000,000 or more). For investors hoping to retire with $1,500,000 to $4,000,000, however, this is a pretty critical decision. If you have annual income between $100,000 - $210,000, a $50,000 swing makes a big difference.
|Decision parameters||$300,000 Home||$500,000 Home|
|View of home||Seeking a comfortable place to live but want to spend money on other things||Home is your castle, desire to spend a lot of time there|
|Job Stability||Possibly concerned about job loss in critical saving years||Feel will be able to work to full retirement age or until have saved enough|
|Retirement savings||Adequate but would like to save more||Well ahead of the game, saved a lot when younger|
|What you want to do in retirement||Travel, participate in activities that require more discretionary income||Garden, maintain your home, entertain at home|
|Helping parents or children||A smaller home will give you more resources to help out||May find budget is just too tight to help out|
|Would like to have a second home||Gives you the flexibility of having that modest second home||Unlikely that you will be able to afford a second home|
Home buying decisions are critical decisions. Unfortunately, too few people meet with an advisor to discuss the trade-offs they are making when they make a home purchase. It is a rare realtor that will help you really look at your situation - their main focus is what percent of your income are you spending on a mortgage, so they understand what you qualify for. That qualification to make the payments does not consider where you are in the retirement life planning cycle.
Homes are often the most expensive purchases in a person’s life, and a second home – bought just at a time when earnings may be peaking and the sense of wealth is highest – can feel more attainable at an even higher cost. A second opinion to hold against the psychological inertia in this situation is extremely valuable, and can significantly impact retirement options.
Opinions expressed in the attached article are those of the author and are not necessarily those of Raymond James.Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional.