Downsize, rightsize or get out of the market?

Q. We are planning to retire in a couple of years (I’m 60 and my wife is 58) and want to downsize our house. We currently live just outside downtown Toronto and estimate our house to be worth about $1 million. We don’t have a mortgage as we paid off our home several years ago and are wondering if it’s better to sell our large home and purchase a smaller house now—or to sell the house and just rent a place for the next 20 years or so. I realize that we would have equity in another house but anticipate that the smaller house would cost us about $750,000. We could be better off simply investing this money instead. What do you suggest?
–Mike

A. The right decision for you and your wife depends on what you mean by “better off.” Let me explain.

With real estate prices high in much of Canada, cashing out by selling your home and renting can certainly look like an attractive option right now. But renting so early in your retirement may be premature since it would mean that you may be renting for a long stretch of time—meaning 20 to 30 years or more.

An option you may want to consider is staying invested to some degree in the real estate market for the intermediate term (10 to 15 years) by either “downsizing” or “right-sizing” to a smaller house or condominium unit. You can then reconsider the renting scenario at a later stage in your retirement, perhaps at age 80 or 85.  The equity you have in your downsized home at that time can become a source of income for this later stage in your life. In many cases, the last years of life in your 80s or 90s can often be the most expensive, if you need long-term care. You can think of the home equity from the downsized home as a kind of long-term care insurance that will be there when the house is sold—and you’ll be very glad you have it.

Alternatively,  if you were to sell your home now for $1 million, invest the money and rent a home instead, the money you get from the proceeds, if invested in a portfolio of solid, blue-chip, dividend-paying stocks yielding an average annual return of 4%, will give you a portfolio return of about $40,000 a year. That sounds like a lot of money, but remember that the investment would have to generate enough income to cover both the rent you will have to pay as well as provide the income for other activities or retirement plans you may have for 20 years or more in retirement. And keep in mind that you may also have to pay tax on this amount, depending on your overall annual income.

Of course, other sources of income may be available to you and your wife at retirement—meaning Canada Pension Plan (CPP) and Old Age Security (OAS) benefits, employer pensions, RRSPs*, TFSAs, RRIFs, and any dividends or income from non-registered investment portfolios you might hold. All of these sources of income should be factored into the calculation when you’re trying to decide how much more than the $40,000 annually from your investments you will need to cover all expenses.

Once you have a good understanding of what your total retirement income will be, you will be able to make a better choice when deciding whether to rent or downsize/rightsize.

For instance, if you both have ample savings, investments and pension income coming in at retirement, then downsizing to a smaller house or condo and keeping one foot in the real estate market is a strong consideration. Buying a smaller home for cash and having $250,000 or so from the sale of your large home available for investment will give you a cash cushion if money gets tight or, it can simply provide you with some fun money to enjoy the earlier stage of retirement (age 60 to 75 or so). In the scenario you presented, where you would sell your $1 million home, buy a smaller one for $750,000 and investment the remaining $250,000 (not including real estate commission and other closing costs) in a well-diversified portfolio yielding 4% annually, you could expect about $10,000 a year in investment income during your retirement years.

Mike, the key to making the right choice for you and your wife here is to look at your finances in the context of what type of lifestyle you’d like to have in retirement. Plan your finances for retirement based on the lifestyle you hope to have—comfortable; or lavish with lots of travel and hobbies. You will have a stronger financial plan—and a happier retirement—if you link or match your retirement spending to specific goals and activities you want in your retirement years. That way, there are no surprises that require spending beyond your means.

I hope this helps paint a clear picture for you moving forward, Mike—and best of luck in your upcoming retirement years.

Heather Franklin is a fee-for-service Certified Financial Planner in Toronto.

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About Heather Franklin

Heather Franklin is a fee-for-service financial planner in Toronto.