Ask an Advisor: Should I Downsize to a Smaller Home in Retirement?

Generations of Americans have leveraged their homes to fulfill their retirement goals by downsizing to smaller homes.  Historically home ownership has represented, on average, the second-largest equity holding for most families that have a successful retirement. 

As retirement approaches, individuals are faced with an array of decisions that can significantly impact their quality of life and financial security. One of the major decisions is whether or not to downsize their living arrangements. While downsizing has been a popular choice for many retirees in the past, as a financial advisor working mainly with retirees, a significant portion of the population now opts to remain in their current homes.

Let’s explore some of the main reasons why retirees choose not to downsize.  I believe home ownership has changed because purchasing a “starter home” has become so expensive.  This trend has caused retirees to stay in place in order to help the next generation.   Below are three reasons I see why retirees not downsizing.

1. Not Downsizing in Retirement

While downsizing can free up equity and reduce ongoing maintenance costs, it may not always lead to significant financial gains. The real estate market is dynamic, and factors such as location, housing demand, and market conditions play a crucial role in determining the potential proceeds from selling a larger home. 

The first $500,000 of a married couple’s sale is tax-free ($250,000 for individuals) if they lived in the house for 2 out of 5 years, but the remaining gain will be taxed at normal capital gains rates.  Retirees will also need to add to the cost of selling a house, like paint, carpets, staging, and real estate transaction cost. Some retirees may find that the financial benefits of downsizing are not substantial enough to warrant a move.

The second part of the financial cost that retirees face is transitioning into another residence. Retirees might earn enough from the sale of their home to buy their smaller home outright, but because of today’s sky-high prices, taxes, and liquidity needs, many will have to take out mortgages to help in the transition.  In addition, if this new home is going to be a forever home, some remodeling/upgrades may be needed to allow an individual to age in place.

To avoid being house-rich and cash-poor, retirees may look at mortgages with rates near 7%; home loans are expensive.  Many other costs, like storage and relocation costs, can add up quickly. There are times when the transition cost alone can be so overwhelming that after some research, it makes more sense to stay in place even if you can take a significant amount of equity out of your house.

2. Emotional Cost 

For many retirees, their homes hold a deep emotional significance. These homes have witnessed the growth of families, the creation of cherished memories, and the milestones of life. The attachment to a familiar environment, neighborhood, and community often outweighs the practical benefits of downsizing. Leaving behind a place filled with sentimental value can be daunting and may deter individuals from making the move.  Especially as individuals age, the community, and familiar faces can provide a social structure and help when additional assistance is needed.

Retirement is also a period marked by significant life changes, including the end of a long-term career. For some, maintaining a larger home symbolizes a continuation of their identity and status, even after retirement. The comfort of having ample space for hobbies, collections, and social/family gatherings can provide a sense of stability and familiarity during this transitional phase. 

3. Family

Retirees often have children and grandchildren who regularly visit, especially if there is a swimming pool, BBQ, or lawn games. A larger home can accommodate these family gatherings, fostering a sense of togetherness and ensuring the family unit remains closely connected. In such cases, downsizing might result in limited space, potentially discouraging the decision to move to a smaller residence. 

Children may also be unable to afford a similar residence in the same location.  Often, children may start in starter homes and soon realize they can’t afford to live in the same area without some trade-off.  We are seeing an uptick in blended family residence arrangements which allows children to get into a larger residence, and retirees have help.  In the case where children do not live in the area, downsizing may not make sense since children may come together to keep the family residence as a vacation home.  

Downsizing may not be in your best interest, financially and emotionally.  Moving from a larger home with a lot of space to a twelve hundred square foot condo may be difficult. 

As we work with clients, we find the economics make less sense, and the ability to help the next generation has made the family residence more of a financial planning tool than a home.  Families are using equity in their current homes to help the next generation –  from blended family living to the potential legacy of a family home. 

Even if your children have no desire to keep your house, getting a step up in cost basis may save thousands. To keep family harmony, steps need to be taken to ensure equalization of the estate and compliance with gifting laws. We are here to help create a strategy so that you and your family can make your wishes come true in the most tax-efficient way.

This article was originally published here and is republished on Wealthtender with permission.

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Disclaimer: This article is intended for informational purposes only and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.