4 Mistakes People Make When Downsizing in Retirement

Reviewed by Margaret JamesReviewed by Margaret James

Many people fantasize about financing a good chunk of their retirement by selling their current home, buying a smaller place, and investing the difference for income. In reality, however, they often reap far less profit than they might have hoped.

Done right, downsizing can still be a good idea. You might not just walk away with more money but also simplify your life and reduce your home maintenance and utility costs for years to come. To reach that happy outcome, you need to steer around the unexpected pitfalls that can make downsizing a bit dicey.

Here are four traps that await downsizers, with ways to avoid each.

Key Takeaways

• Downsizing to a smaller home in retirement must be done wisely.
• You need to accurately determine your current home’s worth.
• You need to be clear-eyed about the cost of your new home—and the cost of moving there.
• You need to look carefully at the tax implications of a move.

1. Overestimating What Your Current Home Is Worth

It’s easy to fantasize about the high price your house will fetch. Perhaps the neighbors down the street sold theirs for an extravagant sum—or so they said—and were last seen packing their new Bentley and heading for Acapulco. Chances are that you don’t know three important things: what they actually netted from the deal, how their home differs from yours in qualities prospective buyers most value, and whether the real estate market at that point was better or worse than it is now. 

What to Do Instead: Any number of websites, including Realtor.com and Zillow.com, will give you information on what homes in your area have sold for recently. You can also use online estimators from major banks, such as Bank of America and JP Morgan Chase, to determine a home’s value. It’s best to check several of these, in part because they each use different formulas to arrive at their estimates. 

Another option is to consult several local real estate agents for an estimate of your home’s current market value. Getting more than one is important, because an agent who desperately wants your listing might give you too rosy an estimate.

You could also hire an independent appraiser.

When you’re talking to the agents or appraisers, ask about inexpensive things you can do to boost your home’s selling price. Most experts say that major renovations aren’t a good idea unless your home is a total wreck, because they rarely recoup their cost. In Remodeling’s “2024 Cost vs. Value Report,” the project that recouped its value the most—replacing a garage door—had an impressive return-on-investment (ROI), at 193.9%. But many projects fell far short of that. A minor kitchen remodel (midrange, about $27,000) recouped 96.1%, which means you would likely just about break even if you attempted one. A major kitchen remodel (midrange, about $80,000) is another story, however: with this renovation, you’d likely only recoup 49.5%. A bathroom addition (midrange, about $59,000) had one of the lowest ROI, at 38.0%. The lesson here: Consider saving yourself the money and hassle and let your home’s next owners deal with some of these projects; their tastes may differ from yours, anyway.

Still, a few simple spruce-ups, such as fresh paint here and there, pruning overgrown shrubs, and de-cluttering your home from top to bottom can be worth the effort. If you wish, you can engage the services of a professional home stager to help you.

2. Underestimating What a New Home Will Cost You—and the Cost of Moving, Too

Just as people tend to be optimistic about what their homes will sell for, they’re likely to imagine that they’ll get a steal on the next place they buy. It’s worth remembering that the potential buyers of your current home—and the sellers of your next one—are thinking the same way.

What to Do Instead: Use the tools listed above to research recent sales prices to find what you can expect to pay for the type of home you plan to buy. If you’re thinking of moving to a new area, there’s no substitute for spending some time there and visiting potential homes. Even if you’re familiar with a place from vacationing in the vicinity, it could pay to visit in different seasons to make sure you’ll be happy there all year. A prudent course—if you have the time and patience—is to move to the area and rent for a year or so before buying. Far too many retirees move on impulse, regret their decision, and end up calling for the moving van again.

And don’t discount the cost of moving itself: according to Moving.com, the average cost of moving a four- to five-bedroom house’s worth of items over 2500 miles is $9,546 – $14,107. Moving the same amount of stuff between 1,000 and 2,499 miles costs an average of $6,378 – $10,002.

3. Ignoring the Tax Implications

According to current Internal Revenue Service (IRS) rules, with the sale of a home, most couples can exclude up to $500,000 in gains from their taxable income. That means you won’t need to pay taxes on the first $500,000 in profits you make from selling your home. Singles can generally exclude up to $250,000. The rules also take into account how long you’ve owned and lived in the home, among other factors. They’re all explained in IRS Publication 523, “Selling Your Home.”

Even if you don’t owe income tax, there are other tax considerations to factor in before you choose to move. Some popular retirement destinations have high property taxes. A location with low property taxes might have higher sales or income taxes, or it might tax pension income differently.

What to Do Instead: First, try to determine your likely gain. That’s not just the difference between what you paid for your home and what you sold it for, but the difference between the selling price and your home’s cost basis. Cost basis includes what you paid initially plus any permanent improvements you made over the years. IRS Publication 523 explains those too.

Compare the income taxes and property taxes of where you plan to move with those of your current location. Also, look into any special breaks for homeowners over a certain age. The state’s tax or revenue department website is a good place to start. Figure the new tax situation into your retirement budget and see whether it will cut your tax bill or result in a higher overall tax burden.

6%

The amount you’ll likely pay in real estate commissions on a home sale. Note that this isn’t a fixed rate required for every real estate transaction.

4. Forgetting About Closing Costs

If it’s been years since you bought a home, you may have forgotten all the closing costs you had to pay at the time. Those probably included legal fees, recording fees, title insurance, and a long list of miscellaneous charges. Not only will you have to pay closing costs when you buy your next home, you’ll also be faced with a second set as a home seller. Most significantly, according to Realtor.com, those can include real estate commissions as high as 6% and sometimes higher, if you use an agent.

What to Do Instead: Agent commissions can be negotiable, so try to get the most favorable possible figure nailed down at the outset. As a buyer, you might be able to persuade an eager seller to absorb some of the closing costs, but you should bear in mind that whoever buys your home will probably try the same maneuver on you. Otherwise, plan to bring your checkbook and write a lot of checks.

What Are the Benefits of Downsizing My Home in Retirement?

Downsizing your home in retirement can reduce your housing expenses, including mortgage payments, property taxes, insurance, and maintenance costs. Additionally, a smaller home often means less upkeep and maintenance, freeing up time and resources for other retirement pursuits. Downsizing can also unlock equity in your home if it has appreciated in value.

How Can I Maximize the Proceeds From Selling My Home in Retirement?

To maximize the proceeds from selling your home in retirement, work with a reputable real estate agent who understands the local market and can help you navigate the selling process, especially regarding the particulars of your home. Additionally, consider making any necessary repairs or upgrades to increase your home’s value and attract buyers, but only if it makes sense from a financial perspective.

What Are Some Common Mistakes to Avoid When Downsizing in Retirement?

Be mindful to not underestimate the time and effort required for downsizing. Also, take care not to overspend or embark on unnecessary renovations. It’s also important to think about how downsizing can be an emotional decision that you should be ready to mentally prepare for.

The Bottom Line

Downsizing your home can be a way to free up some additional cash for retirement, but you should run the numbers before you start packing. You may find ways you didn’t realize would save you money on the switch, or you could decide it pays to stay where you are, at least for now.

Read the original article on Investopedia.