Why Owning A Home Can Be A Valuable Retirement Asset
Is home ownership a mistake in retirement? That’s what this article in USA Today claims. In continuing the theme of my last article about not believing everything you read in personal finance, let’s look at some reasons why owning a home free and clear of a mortgage can be one of the best assets you can have in retirement:
Your variable costs are lower
As the article points out, it’s true that property taxes and maintenance costs increase over time with inflation. However, those costs are still passed on to renters in the form of rising rents. On the other hand, inflation can also cause rising real estate prices, which act to your benefit as a homeowner (more on that later).
You reduce “sequence of return” risk
Of course, not owning a home outright means you can have more invested in the stock market. When you’re working and planning for retirement, that’s a good thing since the rate of return in stocks tends to be higher than the cost of a mortgage. (You’re better off investing money at a 7% to 10% rate of return than paying down a mortgage at a 3% to 4% interest rate.) But when you’re retired, the money to pay those rising rents often comes from selling your stock investments.
The problem here is “sequence of return risk.” Let’s say that over a 30-year retirement, your investment portfolio earns an average return. However, that may come in the form of a really poor 15 years followed by a really strong 15 year period. When you’re buying stocks, this isn’t really much of a problem. When you’re selling stocks, you can end up depleting most of your portfolio in the first 15 years, leaving very little to benefit from the strong returns over the next 15 years.
One benefit of not having a large mortgage or rent payment, is that you don’t have to withdraw as much from your portfolio, which reduces the risk of depleting your account during a period of low returns. Owning a home outright is like having a guaranteed tax-free income equal to the difference between your taxes plus maintenance costs and what you’d have to otherwise pay in rent or mortgage payments. You basically trade the upside potential returns of stocks for lower risk, which is generally a good trade-off in retirement.
You can generate income
Owning a home can also protect you from “sequence of return” risk by giving you another source of income. As long as you’re at least age 62 and have equity in a home, you can take a reverse mortgage that allows you to borrow against your home and not have to make payments as long as you live in it. You can use the money as an income source to reduce the amount you need to withdraw each year from your investments or to pay for unexpected emergency expenses (like home repairs). Just make sure that you’re aware of the costs.
You can also generate income by renting out part of your home. You can do so either long-term to a tenant or short-term on sites like AirBnB and HomeStay. Landlord restrictions tend to make this much harder when you’re renting a place.
The benefits of owning a home outright are more tax-efficient
Many of the advantages above are also more tax-efficient. Property taxes can be tax-deductible, while rent is not. If they’re in a regular, taxable account, stocks incur taxes on dividends and capital gains each year. The main returns from owning your home are “imputed rent” or being able to live there rent-free, which is not taxed, and appreciation, which is tax-free up to $250,000 per person (or $500,000 for a married couple). Finally, the proceeds from a reverse mortgage are also not taxable.
Of course, there are situations in which renting or keeping a mortgage in retirement can make sense. You might have a really good deal on a rent-controlled apartment or need the flexibility of renting. You may have enough from Social Security, pensions, and/or dividends and interests to cover all of your expenses (including your rent or mortgage payment) without having to sell investments. If you’re not sure, consult with a qualified and unbiased financial planner. Housing in retirement is too big a decision to leave to a single article.