Downsize, rightsize, or get out of the market, while in the pre-retirement stage?
With real estate prices insanely high in Toronto, cashing out by selling your home and renting can certainly look like an attractive option right now. But renting too early in your retirement may mean that you’d be renting for a long stretch of time—think 20 to 30 years or more.
An option you may want to consider is staying invested in the real estate market in a shorter term (10 to 15 years) by either “downsizing” or “right-sizing” to a smaller house or condominium unit. You can then reconsider renting when you are in your late 70s or 80s. 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 are one’s most expensive years, because long-term care is often needed. 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 thank yourself later when you need it.
Now, if instead you were to sell your home for $1 million, invest the money in a portfolio that yields a few per cent return, and rent a home, you will receive a return of about $30 000 to $50 000 a year. That sounds like a lot of money, but remember that the investment would have to cover renting costs, as well as costs of long-term retirement. And keep in mind that you may also have to pay tax on this amount, depending on which income tax bracket you fall under.
Of course, other sources of income may be available to you 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 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 have a partner, and both of you have ample savings, investments and pension income coming in at retirement, then downsizing to a smaller house or condo is a strong consideration. Buying a smaller home for cash and having a few $100 000s or so from the sale of your large home 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 (60s to early 70s). In the scenario where you sell a $1 million home, buy a smaller one for $750,000 and investment the remaining $250,000 (not including extra real estate costs) in a well-diversified portfolio yielding 4% annually, you could expect about $10 000 a year in investment income during your retirement years.
The key to making the right choice for you (and your partner, if applicable) 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 lots of travel and hobbies. You will have a stronger financial plan for retirement if you link or match your retirement spending to specific goals and activities you want in your retirement years, and there will be no surprises.
Good luck, and have fun (when you get to your retirement years)!