Your House Is Not a Retirement Plan
The equity you build up in your home is not a retirement-savings account, although many Americans are tempted to think that it is. But the smartest way to think about home equity, financial planners say, is as a cushion -- something to tap only if your savings calculations are off or cash runs out.
Because shelter is a necessity, many planners classify the home as a "use asset," a consumer need in the same class as a car or sofa.
"It's a place to live, not a brokerage account," says Sherman L. Doll, a personal financial specialist with Capital Performance Advisors in Walnut Creek, Calif. "But try to convince a Californian of that." The recent housing boom has boosted the net worth of many Americans, especially those in markets such as California that experienced steep home-price appreciation over the past several years.
But those gains have come with a downside. A recent Securities Industry Association retirement study identified a "wealth effect" that surfaced as homeowners amassed equity in their properties and perceived they had less of a need to save. Factors such as rising interest payments and higher energy prices also pushed Americans to slack off when it came to building their retirement nest eggs, the study concluded.
For many American homeowners, nearly half of their net worth is based on the value of their home, the study found. At the same time, the numbers and percentages of households holding a retirement account such a 401(k) or an individual retirement account have fallen since 2001, and nearly half of American households aren't saving at all. The study estimated that half of the next wave of retirees -- the baby boomers -- will be unable to maintain their living standard in retirement, even if they postpone it.
Know the Real Value
In a way, people are correct to consider a home -- often their largest asset -- as something that will help in retirement, says John Faber, a financial planner with Ronald Blue & Co., Holland, Mich. But they must understand just how it will help.
"There is value there, but many mistake what that value is. For instance, if a person owns a $500,000 home, they think they have a lot of money saved up," he says. But "the biggest retirement benefit of owning a home is to have it paid off and have the privilege of living there without having to make payments or pay rent."
Two Ways Home Can Help
That said, there are two situations in which home equity could be depended on for retirement, financial planners say.
One is if the homeowner plans on downsizing his or her home and putting some of the sale proceeds into more-liquid investments, says Heather Locus, partner with Balasa, Dinverno & Foltz, a private wealth-management firm in Itasca, Ill. Even then, the move could be risky.
Though this might sound like a good strategy at age 40, it may not be right as a client gets older and actually faces the reality of selling the home, Ms. Locus says. The decision gets difficult as the owner's memories and feelings of comfort weigh against any plan to sell.
Some retirees planning on downsizing may also be startled when the smaller home they seek out isn't significantly cheaper than their current one, says Brett A. Coffman, a financial planner with Matrix Wealth Advisors, in Charlotte, N.C. "A retiree who thinks that he can trade his 4,000-square-foot home in for a new 2,000-square-foot town home and pay only half what his [current] home is worth may be very surprised," he says.
A lot of construction around the country is catering to baby boomers nearing or entering retirement, and the new buildings often add features to cater to retirees' needs, which can make the homes more expensive.
The other time home equity can be considered part of retirement savings is when a homeowner decides to take out a reverse mortgage for an income stream, a choice that many planners believe should be a last resort because of the typically high fees it takes to get a reverse mortgage.
"These work best for what we call house-rich and cash-poor," says Scott A. Leonard, president and owner of Leonard Wealth Management in Redondo Beach, Calif. "It is not uncommon in California for someone to be living on Social Security income only and own a $3 million home. They don't want to move, so a reverse mortgage is an option."
Spend Less, Save More
Both scenarios assume that retirees' home equity is mainly intact by the time they stop working. But Frank Fernandez, SIA's chief economist, is concerned that people aren't adequately moving toward the goal of paying off their homes and instead are withdrawing equity prematurely.
He points to the "liquidification" of real-estate value as a problem for many Americans, especially those with most of their net worth tied up in their homes. "If that's all you have, or it's a critical part of retirement income, you shouldn't be spending it before you retire," he says. For some, tapping home equity is akin to "spending retirement savings today."
It's a change from previous generations, when people worked toward paying off the family house so they could hand it down to kids, he says. Future generations would do well to learn from the boomers' experience and start saving early.
In general, Michael Steiner, a wealth manager with RegentAtlantic Capital in Chatham, N.J., recommends committing to a retirement plan and not procrastinating with your contributions. And instead of looking at your house as a "piggy bank," leave it out of the eq
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