Retirement can be a very difficult transition. The primary challenge many focus on tends to be how to spend your time now if you are no longer working every day. However, as we help clients with their financial planning, we often find that an even bigger issue they are struggling with involves decisions around their residence. Where do they want to live once they stop working? Is it reasonable to grow old in their current home? Do they want to move to be near their children and grandchildren? If they are thinking of moving to a new area, should they rent first or just buy something? For many of our clients, these often tough and emotional decisions become some of the most important ones they make as they transition to retirement. All of these are issues we have discussed with clients in the past few months. Maybe you are thinking about them too! Here are some thoughts on issues we see clients facing and how to approach them.
What does your ideal retirement look like?
Our financial planning process starts with an understanding of your goals and aspirations. What is the life you want to lead, especially as you go through a major life event such as retirement? Stepping back to think through this is an important starting point before we even start to work through the numbers. A good way to do this is to answer the three questions from life planning expert George Kinder, which we discussed in detail here. This can often help guide you to the ideal retirement.
What can you afford?
Not everyone can afford their ideal retirement and all financial plans require tradeoffs. You might want to buy a yacht and sail the caribbean for your remaining days, but most people likely don’t have the financial resources to do so. Understanding what you can afford given your financial assets is at the core of our financial planning process. The best place to start in this analysis is to take a hard look at your current expenses, including housing. Breaking these expenses out into discretionary and fixed categories will help you determine what you might change in the future. Next you’ll want to review the value of your financial assets, and run some analysis on whether your assets are sufficient to cover your expenses. If not, you’ll have to consider cutting back on some expenses, or maybe downsizing your residence to increase your asset base.
How will taxes impact your decision?
Income taxes are also an important consideration when looking at housing decisions in retirement. Your state of residence will have state income tax and estate tax implications and can often be a key factor in our clients deciding where to relocate once they stop working. We don’t recommend anyone make a major life decision like this only for tax reasons but they need to be considered.
The deductibility of mortgage interest has been an important aspect of the tax code for decades and needs to be considered in any housing decisions. Under the TCJA, the standard deduction was greatly increased, and we are seeing more clients, especially if they have paid off their mortgages, not benefiting from itemizing their deductions. If you no longer receive a tax benefit from the mortgage it might no longer make sense to keep it.
If you are considering selling your primary residence in retirement you also need to understand any tax consequences of the sale. The capital gain exclusion of $500,000 for married couples ($250,000 for singles), means that very few individuals will owe taxes on the sale of a residence. However, you need to make sure you meet the principal residence rules, including the requirement that you lived in the home at least 2 out of the last 5 years. When calculating your gain you should also remember that you can include major renovations done over the years as part of your cost basis.
Will you have a vacation home?
Many people envision retirement in a warm, sunny location, but they struggle with the thought of leaving behind friends and family. Buying a vacation home could be an option for some people, but it might be a stretch financially for others. We often see clients downsize their primary residence and use that money to buy a second home in a more desirable location. Whether you already own a second home or are planning to purchase one, you should consider the costs to carry it and how it fits into your longer range planning. Sometimes it makes sense to rent the vacation home when you aren’t using it to cover the costs. We also often recommend clients do long-term rentals before purchasing a second home to make sure it is somewhere they’d want to be long-term.
Where will you live when you get older and need assistance?
As our clients get older, we often help them think through the decision to move into an over 55 community or a Continuing Care Retirement Community (CCRC). There are a wide range of options in this area, varying greatly by amenities, pricing, location, etc. Starting with a discussion about what you might be looking for in such a community is important. Then the financial aspects of a decision need to be considered. We have also seen clients who are struggling with chronic diseases trying to assess the impact of the disease on their housing options now and in the future. This certainly needs to be considered in the CCRC decision process too and a plan should be put in place before the time comes when you might need it.
What will happen to your house after you die?
Another area to integrate into this decision is your estate planning goals. We often see clients who own a vacation home that has been in the family a long time who want to make sure it will stay in the family after they are gone. Having discussions with all family members will help you make the best decision for the entire family. The next generation will need to work together on issues like usage and costs when the parents are gone, so having those discussions early in the process could help avoid family fights in the future.
While we have a much higher federal estate tax exemption now ($11.4 million per spouse), many states have different estate tax exemptions. Some states also have complicated rules regarding real estate so you need to consider the estate tax laws in your state of residence and the state where you hold any real estate property. Also keep in mind that real estate is not a liquid asset for funding any estate tax liability.
Let us help you think through this!
Housing decisions are an emotional and financial aspect of financial planning that becomes even more important as you approach retirement. Working through them in a thoughtful way while considering all the various aspects that might come into play is the smart way to make decisions. We understand how hard these discussions can be and are glad to serve in a role of helping you think through them.
- Lyle K Benson Jr., CPA, PFS, CFP
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.