Last month I explored the emotional challenges of selling the family home in retirement and moving to a smaller dwelling. This article looks at the key financial issues to consider if you are downsizing to replenish your savings.
This is a popular strategy to re-invigorate the household balance sheet, where the value of your home has risen steadily over the years but as retirement plays out, you find yourself running low on cash.
A study by the Australian Housing and Urban Research Institute found the majority of older Australians are motivated to downsize for reasons such as lifestyle preference, an inability to maintain the house and garden, retirement, children leaving home, and deteriorating health; 10 per cent of those surveyed cited financial gain as their motivation for selling up, while 6 per cent pointed to financial difficulties as the driver of their decision.
Downsizing is not for everyone, but in my experience, it is usually some combination of the above factors that triggers the decision to sell up in pursuit of a simpler life and a smaller home. Yet while simplicity may be your goal, there are a lot of ‘moving parts’ involved, and you need an appreciation of how they all interact to boost your chances of a successful outcome.
An awareness of the economic environment is also useful.
Right now, a weakening residential property market may mean you achieve a lower-than-expected sale price on the family home, while record-low interest rates make it harder to generate enough income from any funds you have left over.
Throw in frequent changes to Centrelink thresholds and the introduction of new downsizing super contribution rules, and you get a sense for the range of issues you and your family need to think through. Professional advice is well worth considering to help you weigh up your options, but in the meantime, following the steps below will ensure you approach the downsizing decision with your eyes open.
Understand your ‘why’
It pays to be clear on why you are downsizing and what you hope to achieve. If your downsizing mission is driven by financial necessity, there is little room for error.
Start by being realistic – smaller doesn’t always mean cheaper. In most capital cities, selling a typical house in the suburbs is unlikely to free up enough to buy a smaller, waterfront apartment, let alone create a residual amount to generate ongoing income. The balancing act is to find a smaller property you can comfortably call home, while leaving yourself with enough invested to meaningfully boost your cash flow.
Do the numbers
Despite our national obsession with all things property, it is easy to underestimate some of the expenses involved in buying and selling. Your expected downsizing proceeds can easily evaporate if you miscalculate your transaction and relocation costs.
It is essential to make reasonable estimates of the outlay involved in selling your home. In addition to marketing fees, legal expenses and the cost to prepare your property for sale, the largest impost is usually in the form of real estate agent fees or commissions. Whilst a number of fixed-fee agents have emerged in recent times, the average commission in most states is between 1.5 percent and 2.5 percent of the sale price, or as much as $15,000 to $25,000 on a $1 million sale.
Then, when buying a new dwelling, stamp duty is usually your largest expense (around $27,000 on a $700,000 purchase in New South Wales), in addition to building and pest inspections, legal costs, and of course moving expenses. You may also wish to budget for things like new furniture, storage, and any initial modifications required to make your new house feel like home.
When crunching the numbers, it is easy to focus just on the initial costs while failing to appreciate the substantial ongoing expenses that accompany your new dwelling. The most common example is the requirement to pay strata levies in a new apartment, as this can add several thousand dollars per year to household spending.
You also continue to incur various maintenance costs, so it pays to take the time to do a detailed budget before and after you relocate, so you have an accurate guide to the level of income you will need once you settle into your new abode.
Solve the Age Pension puzzle
This is one of the most important impacts to understand, and a source of concern for many as they mull over the downsizing option. While a reduced Age Pension entitlement can be a disincentive to downsize, I urge clients who qualify for Centrelink benefits to focus on the total income generated from their financial resources after downsizing, not just the change in the Age Pension.
In simple terms, where you have funds left over after selling the family home, you have released equity that was once exempt for Centrelink purposes, and those funds are now factored in to the calculation of your fortnightly entitlements.
For those choosing to rent for a temporary period after selling, bear in mind Centrelink disregards the proceeds of sale for up to 12 months (for assets test purposes), provided you intend to use the funds to purchase another home. Sale proceeds will however be subject to deeming which may reduce or eliminate your Age Pension until you buy a new property.
While it is common to experience a reduction in your Age Pension after downsizing, remember that you can also generate investment income from your residual funds, and with careful planning, in many cases it is possible to emerge from the downsizing process with more income than you started with.
The key is to understand how your Centrelink payments will change, and once that is known, your aim should be to generate as much income as you can from the money you have left over (with consideration for the level of risk that is appropriate in your circumstances).
Know the rules
When it comes to the rules governing super and Centrelink, we are frequently reminded that the only constant is change. The good news is, that since July 2018, the federal government has actively encouraged older Australians to downsize with a new initiative designed to remove a barrier for older Australians to move from homes that no longer meet their needs.
The new rules are an opportunity for over 65s to use downsizing proceeds to contribute up to $300,000 to super as a non-concessional contribution (up to $600,000 for a couple). The attraction is the ability to then commence a tax-free income stream (up to legislated limits), while the usual requirement for over 65s to meet the ‘work test’ is waived.
To be eligible to make a downsizer contribution:
Given the overlap of these rules with the existing super and pension limits, and the related Centrelink impacts, it can pay to obtain professional advice before determining which course of action makes sense for you.
Diversify to boost your income
Having sold your home and settled on a new residence, your next challenge is to put the residual proceeds to work to maximise your income. Today’s reality of record low interest rates means the income available from cash and term deposits may fall short of what you need to meet your ongoing expenses.
And while rock-bottom interest rates are terrific for borrowers, retirees seeking income face the dilemma of either accepting 2.5 percent per annum on a term deposit (and spending more of their capital to make ends meet), or moving up the risk spectrum in pursuit of more attractive yields from assets like bonds, hybrid securities, commercial property, infrastructure, and shares.
Yet to speak in such absolutes overlooks the real possibility that a suitably conservative combination of all of the above, could tick the box on higher income, tightly managed risk and steady growth.
It also raises a curly question – in an era of rising longevity where many people spend 25-30 years in retirement, should retirees be more concerned by the prospect of short-term fluctuations in their investments or the risk of outliving their money?
But that is a debate for another day.