Don’t count on home equity for retirement income

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Are you counting on your home to fund your retirement? You’re not alone. A recent survey by Sun Life Financial showed that 24% of respondents believed that residential real estate would serve as their primary source of retirement income. But this could be a false hope, and in my own financial planning practice, I have never seen it happen. Here’s why.

You have to live somewhere…

Typically, when a retired couple or individual is “downsizing,” they are moving from an older home, one that they may have lived in for 20 to 30 years. This home is definitely worth less than a similar-sized new home. Now the question is, What is this couple moving into next? Are they moving into a smaller home that was built around the same time as their first home, or are they moving into a smaller home or condo that is of a newer vintage?

The typical answer is that they are moving into a condo or smaller home, but of a newer vintage. The only problem with this is that this new home may not be that much less expensive than the one that they are selling. In some cases, I have seen people “downsize,” yet still end up with a mortgage.

It seems reasonable to assume that if you could sell your family home after 20+ years, you could move to another community, perhaps further outside of the city, and pay much less. While this may be true in some circumstances, you are also moving away from the community, friends, and family members who may already live close by. Many people wish to move closer to family, friends, children, and grandchildren, which then may mean that you end up spending more money on your “smaller retirement home” than what you had originally expected.

…and there won’t be much left over

Allow me to reiterate: I have never seen a situation where someone has sold their principal residence and ended up with enough cash left over to generate any additional meaningful level of income. In most cases, the retired couple spend a similar amount to buy their new home as they received when they sold their own home.

The “unretirement” survey went on to say that “on average,” Canadians expected to have 10% of their income coming from the equity in their home. Being a financial guy, I was curious to put some dollars around this notion. To do this, I begin with another quote from the survey that suggested that 30% of one’s income in retirement is expected to come from Canada Pension Plan (CPP) and Old Age Security (OAS).

Where the money comes from

Using this as a starting point, full CPP and OAS today could be approximately $1,500 per month per spouse. Let’s assume that the couple is receiving $3,000 per month from these sources, or $36,000 per year. If this was 30% of their income, then total family income would be approximately $108,000 or $54,000 each. This is not uncommon for some.

Now, let’s assume the couple also derives 10% of their income (approximately $10,000) from investments. Working back, and using a dividend rate of 4%, the capital value of the investment would have to be $250,000 to produce that income.

To generate that income, the couple would need to have $250,000 clear from the sale of their principal residence. So, for example, on a $500,000 home sale, they’d have to find a new home for only $250,000 in order to have $250,000 left over to generate income. On a residence worth $750,000, they’d have to buy a new home for $500,000. Perhaps this latter scenario is possible, but it would be realistic for only a small portion of the population.

The hard truth about home equity

My advice is very straightforward: Don’t assume that you will have enough equity in your home at retirement to do this type of flip. In most cases, you’ll simply be “trading” residence value when you downsize.

If you are fortunate enough to end up with some money left over from the sale of your principal residence, it will likely be money that you will need for emergencies, or a rainy day fund, or one or two special holidays.

In my experience, any money you have left over from the sale of your principal residence will not be enough to provide any additional or meaningful income whatsoever, so don’t count on it.

Courtesy Fundata Canada Inc. © 2014. Doug Nelson, B.Comm., CFP, CLU, CIM, is President of Winnipeg-based Nelson Financial Consultants. This article is not intended as personalized advice.