When a client looking to retire sits down with LBW, one of the main questions we ask is “How do you feel about your current living situation?” We ask in order to generate a conversation surrounding the concept of downsizing, and we do this as most people have an opinion. For example, based on a survey produced by TD Ameritrade “42% of American’s plan on downsizing in retirement.” The answers we uncover range from accessing equity to moving to a warmer climate. Once we venture down the “downsizing rabbit hole”, our clients soon realize a seemingly easy financial decision may not be as easy as they once thought.
Downsizing is talked about as if it’s in every retiree’s future. However, what’s not discussed is its reality. When looking to downsize a home the typical reasons are cost, size, and/or location. For example, living in WI means harsh winters and short-lived summers. If a client is an avid golfer, they may want to head to FL or AZ to capture year-round golf, or the current maintenance cost of a home may drive an individual to downsize to reduce overall costs. These are great reasons to make a move, but let’s take a deeper dive into the difficulties for each category.
A large reason for downsizing is to reduce overall cost and access equity to fund retirement endeavors. This reason is not driven by emotion, but by dollars. From a bird’s eye view it makes total sense – sell your current home and either buy a new home at a lower value or rent. However, the data doesn’t necessarily support the idea. For example, in a CNBC article it states, “On average, homeowners age 65 to 74 who downsize sell a $270,000 home and purchase one for $250,000, according to the realtors’ group.” This is because reducing square footage and price isn’t always a one-for-one event.
The difficulty with downsizing to access equity is the need for shelter. No matter what, people need to live somewhere, and when they downsize they tend to roll what equity they have into the new home. This is why net worth numbers sometimes exclude the primary residence, because at the end of the day when a sale occurs there is a subsequent purchase with available equity. For example, let’s assume Ms. Packer owns her home and its worth $270,000. She is looking to downsize and finds a new home in a nearby neighborhood for $250,000. After closing costs for both the purchase and sale and using all her equity to buy the new home, Ms. Packer would have to come up with $9,100 to complete the purchase – it would cost her money to downsize.
Another factor to consider when evaluating cost of downsizing is the residence’s state. For example, we have clients who live in Los Angeles, CA and need to evaluate the property tax consequence of selling and then buying a new home. In Los Angeles, property tax’s average is roughly 1.16% for every $1,000 assessed. Currently, an average price of a single-family home is $710,000. Based on the property tax rate, you will pay roughly $8,236 per year. What is interesting about Los Angeles property tax is that the owner pays tax based on the amount paid for the property. Due to the significant increase in home prices in the area, some retirees may not be able to downsize as the may not be able to afford the property taxes for a new home. For example, let’s assume a couple bought their home in the late 1980’s for $150,000 and it’s now worth $1,000,000. If they decided to downsize and bought a new home for $800,000 (20% less, than their current value) they would go from roughly a $1,740 per year tax bill to $9,280. That is an almost 434% increase in property taxes per year!
As Ms. Packer and a Los Angeles resident witnessed, taking total cost into consideration is essential when downsizing. However, an even more difficult thing to consider is the cost of going from big too small.
The word “downsizing” not only pertains to the hope of cost reduction, but actual reduction of square footage as well. When clients are looking to downsize, they typically want to reduce their house footprint as they don’t feel the need to have more than two bedrooms when the kids are now gone. In addition, as clients age, maintenance of a large home can become extremely burdensome. Once again, from a high level this makes sense. However, the difficulties of an actual move can be enough for someone rethink their decision.
Reducing your footprint has plenty of pros: less maintenance, better use of space, lower utilities’ cost…the list goes on. However, what happens when the holidays come around and kids and grandkids want to come stay for a week – where will they sleep? This may seem like a small issue but has monumental effects. Not having the ability to house family for a week may alter a plan to move. In addition, what about all the loads of “stuff” in the basement, where will it go? Is a storage unit needed? Is parting ways with mementos worth it? And what about the feeling of being on top of one another? Is it going to be easy to only have one to two bedrooms? Will you be able to have your own space? It’s easy to get caught up in the cost of downsizing and assume throwing away +20-year possessions and having family stay at hotels will be easy. Once it is forced the regret may outweigh the few extra dollars saved.
Living in WI, being a “snow bird” and moving south for the winter is a hot topic. Some clients take it a step further and just want out of WI’s extreme temperatures. Others feel the area they currently live is becoming increasingly expensive and the hustle and bustle is something they feel is no longer a good fit. Relocation seems easy – who doesn’t want to play golf or sit on the beach in January? Relocating creates underestimated qualitative trade-offs. For example, what if you have been in the same neighborhood for multiple years and have created a strong bond to friends, schools, and/or religious institutions; are you ready to trade comfortable social encounters for weather? Another potential issue are children boomeranging back to their childhood city. Once they begin their journey of settling down and starting a family, it is easy to venture back to the place of comfort. What happens when you have moved away, and the grandkids are now in the place you used to live for years?
Setting social and family ties aside, relocating to different states or even neighborhoods has a cultural impact as well. I (Tim) have firsthand experience as it relates to a cultural change. Growing up in Salt Lake City, UT and now living most of my adult life in WI has been life changing. Before I made the move, I couldn’t have possibly imagined the differences in values, personalities, and culture only a few states away. Both states have their pro’s and con’s – for personal reasons WI now fits me better, but UT has most of my nephews – this is a trade-off I will live with for years to come. The key takeaway – location is a component that needs serious thought.
Making a financial decision always seems easy at first glance but becomes increasingly difficult once you begin to wade through the weeds. One must weigh their option from a dollar (quantitative) and a quality-of-life (qualitative) standpoint. When viewing a dollar-return one must dig down to see if a move truly produces the optimal outcome. Grabbing all the details and coming up with a true dollar value is paramount. It could be argued for this specific scenario that it is even more important that one should take the next step and evaluate the qualitative aspects. Understanding the qualitative aspects of the decision leads us down a path of values and emotions. Not even our neighbors or close family members can answer those types of questions. Furthermore, the qualitative can conflict with the quantitative – this is why working with a qualified professional can be so beneficial. Working with LBW can provide you with a competent and objective professional that can analyze the hard numbers and evaluate the qualitative components. We strive to educate the families and individuals we have the pleasure to work with, helping them to understand the trade-offs that are typically underestimated. Simply put, when looking to paint a downsizing picture, make sure you have all the tools to create your masterpiece.
 LBW Wealth Management – assumed 8% closing cost for sell and 3% closing cost for buy.
 Moving south for the winter to places such as FL or AZ.