Many older individuals dream of funding a significant portion of their retirement by selling their current home, purchasing a smaller residence, and investing the remaining funds for additional income. However, the reality is often far from what they anticipate.
When executed correctly, downsizing can be a beneficial decision. Not only can you potentially increase your financial assets, but you can also streamline your lifestyle and decrease your expenses related to home maintenance and utilities in the long run. To achieve this positive outcome, it is crucial to navigate around the unforeseen challenges that can complicate the downsizing process.
Below are common pitfalls that downsizers may encounter and factors that should be taken into consideration.
Overestimating the Value of Your Present Home
It is common to daydream about the high price your house could potentially sell for. Maybe you heard that the neighbors down the street sold their home for a significant amount and were last seen driving off in their new Bentley toward Acapulco. However, there are three crucial factors you may not be aware of: the actual profit they made from the sale, how their property differs from yours in terms of features that appeal to potential buyers, and whether the real estate market was more favorable at that time compared to now.
Instead of relying on hearsay, there are several reliable sources you can turn to for accurate information. Websites like realestate.com.au and view.com.au, provide data on recent sales in your area. Additionally, you can utilize online estimators offered by major banks like NAB and CommBank to determine the value of your home. It is advisable to consult multiple sources as each may use different methods to calculate estimates.
Another option is to seek opinions from several local real estate agents to get an idea of your home’s current market value. It is essential to gather multiple estimates as an agent eager to secure your listing may inflate the value. Alternatively, you could hire an independent property appraiser for a professional evaluation.
When speaking with agents or appraisers, inquire about cost-effective ways to increase the selling price of your home. It is generally advised by experts to avoid major renovations unless your home is in dire need, as they often do not provide a good return on investment. According to Remodeling’s “2024 Cost vs. Value Report” (based on the US market) Remodeling, replacing a garage door had the highest return on investment at an impressive 193.9%. However, many other projects did not fare as well. For example, a minor kitchen remodel costing around $27,000 recouped 96.1%, essentially breaking even. On the other hand, a major kitchen remodel costing about $80,000 only recouped 49.5%. A bathroom addition at around $59,000 had one of the lowest returns at 38.0%. The key takeaway is to consider saving money and letting the next owners handle certain projects, as their preferences may differ from yours.
Nevertheless, simple updates like fresh paint, pruning shrubs, and decluttering can significantly enhance your home’s appeal. If desired, a professional home stager can assist in maximizing your home’s potential.
Underestimating the Total Costs Involving Purchasing New Homes
Many individuals tend to have an optimistic outlook when it comes to selling their homes, believing they will get a good price. Similarly, they may also think they will find a great deal when purchasing their next home. However, it is important to keep in mind that potential buyers of your current home and sellers of your future home are likely to think the same way.
Instead of relying solely on optimism, it is crucial to utilize the tools available to research recent sales prices. This will give you a realistic idea of what to expect when buying a home. If you are considering moving to a new area, it is highly recommended to spend time there and visit potential homes. Even if you are familiar with the area from previous vacations, visiting in different seasons can provide valuable insight into whether you will be happy there year-round.
A prudent approach, if time allows, is to move to the area and rent for a year before making a purchase. Rushing into a decision can lead to regrets, especially for retirees. It is not uncommon for individuals to make impulsive moves and later realize they are not satisfied with their choice, resulting in another move.
Additionally, it is essential to consider the costs associated with moving. According to Moving.com, the average cost of moving a four to five-bedroom house over 2500 miles ranges from $9,546 to $14,107. Moving the same amount of belongings between 1,000 and 2,499 miles costs an average of $6,378 to $10,002. These expenses should be factored into your budget when planning a move.
The Implications for the Age Pension
One of the primary concerns for seniors and retirees when considering downsizing is how it will impact their pension entitlements.
In simple terms, when you sell your home, the proceeds will be evaluated against the Age Pension assets and income tests. To continue receiving your full or partial pension once you reach the Age Pension eligibility age, the value of your assets and your fortnightly income must meet certain thresholds.
Fortunately, if you plan to use the proceeds from the sale of your home to purchase, build, or renovate another home, they will be exempt from assessment for up to 12 months. This exemption has been extended to 24 months as of 2023. Additionally, any deemed income from the exempt proceeds will be subject to the lower deeming rate.
For example, under the assets test, if you downsize from a $1 million house to a $700,000 dwelling, the $300,000 difference will be considered an assessable asset 24 months after the exchange.
If your assets exceed the limits for your situation, your pension payments will be reduced. The limits are as follows:
Your situation Homeowner No-homeowner
Single: $667,500 $909,500
Couple: $1,003,000 $1,245,000
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(Source: Services Australia)
Meanwhile, the income test will calculate the deemed income of $300,000 using the current deeming rate of 0.25% until mid-2024. It’s important to note that this rate only applies if the funds are used for a new principal home; if they are held in a financial asset, they will be assessed at regular rates.
To continue receiving your pension, your fortnightly income must fall within the threshold for your specific situation. The income thresholds are as follows:
Your situation Income threshold
Single: $2,397.40
Couple (combined): $3,666.80
However, not all empty-nesters are eager to relocate to a new area. Downsizing within the same neighborhood may not result in as much financial gain once transaction costs are taken into account.
For instance, the median home value in Sydney is $895,000. This means that a downsizing homeowner could potentially be hit with a stamp duty bill of nearly $36,000.
While many find downsizing for retirement to be a relatively easy process, a study by the Australian Housing and Urban Research Institute revealed that one in four individuals encountered challenges. The most common issue reported was the lack of suitable properties available for downsizing.
What Benefits does Downsizing Offer
Downsizing can provide many benefits for seniors, including:
Financial Benefits
Downsizing can provide financial benefits by freeing up cash that can be used to pay off a mortgage, invest, or spend as desired. The equity from selling a larger home can be utilized for a variety of purposes.
Reduced Costs
Moving to a smaller home can result in reduced costs as it is usually cheaper to insure and maintain. Heating and cooling a smaller home is also more cost-effective. Furthermore, a smaller home requires less effort to clean and upkeep.
More Time
By downsizing, seniors can free up more time to focus on hobbies, travel, or spending time with family. With fewer responsibilities, seniors can enjoy a more relaxed and fulfilling lifestyle.
Government Incentives
Some states offer incentives to assist seniors in purchasing a smaller property, such as stamp duty waivers. These incentives can make downsizing a more financially attractive option for seniors.
Additionally, seniors who downsize may be eligible for stamp duty concessions based on their state of residence. This incentive allows downsizers to potentially save thousands of dollars in taxes charged by the government for the purchase of their new property.
Lifestyle Changes
Downsizing can lead to lifestyle changes that can improve the quality of life for seniors. It allows them to choose a location closer to family, transportation, and services. Additionally, downsizing can provide an opportunity to update their social life and engage in new activities.