When planning for retirement, sooner or later “downsizing” comes up in the conversation.
You downsize your home, your car, your lifestyle – be it eating out less, shopping less, traveling less. Less becomes best.
For many people, downsizing is a prudent strategy if they do not have enough money set aside to meet their current standard of living or the economy forces them to take retirement earlier than they had planned because of job loss. The strategy to downsize usually comes from a need, not a want, says Marlene Dattilo, a certified financial planner with Financial Architects. In a 2011, MassMutual Retirement Services study, 54 percent of those polled said they would have to reduce their standard of living and 64 percent said they expected to work at least part-time in retirement.
Downsizing has plenty of advantages. It enables retirees to access wealth which is stored in their home. As a general rule, wealth stored as home equity is not otherwise accessible for use in retirement income planning. The exception to this is home equity loans or reverse mortgages, but both involve the need to pay interest charges to the lender which can become quite costly over time, says John Hauserman, author of RetirementQuest: Make Better Decisions.
Quite simply, “Downsizing can help ensure that you don't run out of money. It is a means to a goal,” says Steven Levine, a senior member of Levine, Jacobs & Company, certified public accountants.
There are also advantages that have nothing to do with money. “People sometimes overlook that when they downsize they wind up in a community of like-minded retirees, more than willing to watch your home or apartment while you travel or perhaps become traveling companions for a world of adventure waiting for you out there,” says Kym Anderson, a CPA with Jones & Company, certified public accountants.
Anticipate the reality of less
But for all the upside of downsizing, there is a downside.
“Change is as much a disadvantage as an advantage. Moving is always stressful, but even more so in retirement. It seems to be an end to an era, giving up familiar surroundings, neighborhoods and friends,” says Anderson. Deciding what can and should be moved can be very painful. Downsizing means less room for all the treasures you've collected over a lifetime.
For sure, downsizing is an emotional issue. “You want to visit your grandchildren. You want to be able to give them some of things you couldn't give your own children when they were growing up. Having to spend less is often a challenge in the face of these things,” says Dattilo.
New retirees are often already experiencing dramatic life changes just from leaving work. Adding additional stresses like moving, especially if away from family and friends, may not be a good idea and can lead to depression, points out Hauserman.
Make your decision carefully
The decision to downsize should not be made lightly. Sure, if you sell your home it can translate into immediate savings in monthly mortgage payment, upkeep and utilities. If your home is paid off, you will be able to invest the difference between the sales price and the cost of your new home. Generally, too, any gain from the sale is tax free, says Anderson. But, explore all options. Maybe you can work longer, or work part-time in retirement to avoid making drastic changes.
Have a good idea of your income and expenses. Know what's coming in for sure – like social security, pension, and annuity payments, for example, and what's going out, mortgage or rent, utilities, food, and what can be changed or cut, explains JP McDermott, a financial advisor with MassMutual.
If you are considering selling your home, be sure you know how much time it could take to sell and what the out-of-pocket costs to prepare the home for sale will likely be. Where will you move to? Will you rent or buy? What is your price range?
“Start planning on what you'd like to end up with and then work backwards from that dream to make it happen,” says McDermott.
Don't go it alone. Talk to an advisor to get help planning your exit from the workplace and to help design your distribution strategies to maximize your income in retirement, so that you don't outlive your savings, and maybe even avoid downsizing.