Living in a paid-off home can be a nice way to keep your expenses low in retirement. All you need to worry about are property taxes, maintenance, utilities and insurance.
But what if your home is really valuable? You might own a detached house in an expensive city. Or, you might live in a home that was perfect for a family with kids but too big for one or two people.
You could cash in on your housing market luck and use the investment returns to rent a place perfectly suited to your retirement plans.
But would you be better off? Well, it depends.
- How much could you get for selling your home?
- What housing expenses would you be freeing yourself of?
- How much would you spend on rent?
- Are you comfortable managing an investment portfolio, or could you find someone to competently do if for a reasonable fee?
- Do you have much room in your TFSA or RRSP?
- What would your tax rate be on the type of investment income you would receive?
It might be helpful to go through an example to help you think through all the different pieces.
Let’s assume that you could get $1 million for your mortgage-free home, after deducting realtor fees. Not unreasonable in Canada’s largest cities and easy to scale to your situation.
A basic rule of thumb for a typical 30-year retirement is that you can fairly confidently spend 4% of your starting portfolio balance every year (with a small increase every year for inflation).
Using the 4% rule, $1 million would give you $40,000 per year, before taxes. For someone living in Ontario, with taxable income of around $50,000 per year, the average tax rate on an additional $40,000 of investment income from a typical globally diversified “balanced” (60% stock, 40% bonds) portfolio would be about 13.5%. It’s low in this scenario partly because the starting amount, from the sale of the property, is entirely tax-free (I.e. there are no accumulated taxable capital gains). It would be even lower if you have room in your registered accounts (e.g., TFSA, RRSP) You can find the tax rates appropriate for your situation at TaxTips.ca.
So, in this example, the $1 million portfolio would provide an after-tax income of roughly $35,000 per year (adjusted for inflation) throughout a typical 30-year retirement. That’s about $2,900 per month that could be used for rent.
That covers the income you could generate from the sale of this home, but you would also eliminate some housing expenses. Property taxes and maintenance could each be 1% of the property value per year, so a total of $20,000. Utilities could be $3,600 per year, and home insurance could be $600 per year. In total, these add up to $24,200 per year or $2000 per month.
So, selling this home could increase your after-tax income by $2,900 per month and decrease your expenses by $2,000 per month. That’s a $4,900 per month swing in your finances and enough to rent a pretty nice apartment.
This is just an example to give you an idea of how to think through the question. If you are thinking about selling your home and renting, you should run the numbers for your situation or find a financial planner to do it for you.
Managing an investment portfolio
You have to either manage a diversified investment portfolio or pay someone to do it for you.
The difficulty of properly managing an investment portfolio that you intend to draw down through retirement should not be underestimated, especially if you are new to investing. There is a lot of misinformation out there, and if your idea of investing is stock picking, your million dollar portfolio could disappear real quick. Additionally, we all face cognitive decline in our later years. This and portfolio management are not a good mix.
On the bright side, there are many tools to help with this, like robo-advisors and one-fund portfolio ETFs from Vanguard, iShares and BMO.
Also, you should be able to find a good full-service wealth manager. It’s hard to get good advice with smaller portfolios. With less than $500K to invest, you are essentially stuck with bank salespeople or other “advisors” who only sell proprietary funds with high management fees. But if you have more than that, you can get access to proper advice. Where they charge less than 1% of your portfolio in exchange for financial planning and managing a portfolio of low-cost index ETFs or mutual funds. There are lots of bad companies out there. Trying to talk you out of low-cost index funds is a big red flag.
Investment returns may be lower in the future
Investment returns may be lower than those in the pay used to develop the 4% rule, or there may be a stock market crash right after you invest the proceeds from your house sale. Or, you may need your portfolio to last longer than 30 years. If some or all of these apply, the 4% rule may not be conservative enough. If you want to be extremely conservative, you might want to spend less, possibly the 3-3.5%. There are many safe withdrawal calculators out there. This is also something a financial planner could help you with.
You are out of the housing market
You will not benefit from future house price increases. This is just luck though, so I wouldn’t lose sleep over this. Prices can go up or down, and over the long-term stocks have done quite well compared to real estate.
For many Canadians, their house is their largest final asset, and they like the idea that they will be able to leave it to their children. This may seem like a reason against selling, but your investment portfolio will be generating a lot of income. And if you stick with a relatively conservative withdrawal rate, you may even see it grow throughout your retirement.
Quality of rental units and lifestyle
This is more of a concern in rural than urban areas, but the types of properties that you can rent are not always similar to those that you can buy. In some cases, choosing to rent may mean living in a smaller, lower-quality place. This depends on your local market, though. You may have very similar options in the rental market. You may also prefer to shift to hassle-free apartment living in retirement.
There are strong protections for renters in many markets, including Ontario. And evictions are relatively rare. But it is more common when you are renting from individuals vs large property management companies. Families may be renting out a second home with a plan to sell soon or intending to gift it to their children. Moving doesn’t have to be a big deal if you can afford it and you are relatively minimalist. But it is something that will likely become less pleasant as you get older.
I’m not in a position to say what is best for you.
I just want you to realize that houses are expensive, and an investment portfolio can generate consistent income throughout your retirement.
Once you understand that, then this decision comes down to your personal preferences and the specifics of your financial situation.