Estate Tips for Retirees
by Bambi Holzer with Elaine Floyd
Real estate is the closest thing to the proverbial pot of gold.
—Ada Louise Huxtable
You know what they say about land: They ain’t making any more of it. That doesn’t mean it’s always a good investment, of course. There’s plenty of land in the desert or in locations far from cities and towns that people aren’t much interested in buying. Still, it’s the scarcity factor that gives real estate its appeal as an investment and makes it an excellent hedge against inflation. Although real estate is generally considered a nonliquid investment—better to buy and hold for its potential appreciation over a long period of time—there are ways to generate income from real estate. One is by tapping the equity in your home. The other is by investing in income property or a special type of security called a real estate investment trust (REIT).
TAPPING THE EQUITY IN YOUR HOME
If you’ve owned your home for many years and have not been tapping the equity for things like college, weddings, or credit card debt, you may be sitting on a gold mine. There are several ways to convert home equity into retirement income. You may want to take advantage of them early in your retirement or save them until later, after you’ve used up other resources first.
When you read this article, also keep family members in mind. If you have aging parents who are sitting on a ton of equity but have little current income, why preserve your inheritance when your parents need the money now? You can help them by looking into one of the home equity conversion strategies to be discussed, perhaps even keeping the financing within the family to save fees and get tax benefits for yourself. If you do decide to enter into a loan arrangement with your parents, make sure you comply with all the tax laws. The IRS doesn’t like monkey business going on between family members when it’s done purely to avoid taxes.
Following are some ways to unlock the equity in your home.
Sell Your House and Buy a Cheaper One
With the kids out of the nest, no job to keep you tied to your present location, and no time to maintain a big house what with all the traveling you intend to do, you may decide to sell your big house and move to a smaller one. If so, you can take advantage of one of the biggest windfalls of the Taxpayer Relief Act of 1997 and its subsequent “technical correction” in May 1998 to sell your house and pay virtually no capital gains taxes. The law allows single taxpayers to exclude up to $250,000 and married couples up to $500,000 in gains, as long as they’ve lived in the house for two out of five years before the sale. The previous rules about being age 55 or rolling over the equity to another home are gone. And for what it’s worth, you can do this several times during your lifetime. Selling your big house and buying a smaller one accomplishes two goals: It releases some equity, which you can put into your retirement bucket and draw income as you need it. It also simplifies your lifestyle by giving you less house to maintain.
Sell Your House and Rent
Now that the law does not require you to buy another house within a certain time period in order to get the capital gains tax break, you may want to rent for a while—maybe even indefinitely. If you’ve been a slave to your house for many years, you’ll appreciate the freedom renting can give you. You don’t have to worry about repairs, because the landlord does them for you. You can move anytime you want without worrying about selling your house and getting enough out of it to cover the real estate and escrow fees. And perhaps the best part is that you’ll have a whole pile of money in the bank because you won’t be plunking it into another home. You can put the proceeds from the sale of your house into your retirement bucket, invest it along with whatever else is in the bucket, and draw enough income to pay rent and other expenses. For example, let’s say you net $200,000 from the sale of your house. If you invest it at 10 percent, you’ll earn $20,000 a year. If you draw 8 percent income (allowing the other 2 percent to grow), that’s $16,000 a year, or $1,333 a month—enough to cover rent in most places.
If you’re worried about losing the ongoing tax break that home ownership provides through the deductibility of mortgage interest, you may want to take a fresh look at your tax situation. For one thing, your tax bracket may be lower in retirement. For another, when you factor in maintenance, repairs, property taxes, and insurance, home ownership may not put you ahead after all. If you’re a numbers person, you or your accountant can do some calculations to see what would be best for you. But since the numbers are often very close, a better way to approach the rent-vs.-buy decision may be to look at your goals and overall lifestyle. If freedom, mobility, and simplicity are important to you, think about renting. If stability and pride of ownership are values you cherish, think about buying.
Stay Where You Are
If you love your home and can’t bear the thought of moving, there are several ways you can free up some of your equity for retirement income without giving up your beloved abode.
Reverse mortgages are designed to allow retirees to stay in their homes and enjoy the use of the equity now, when they need it, rather than passing it on to heirs after they’re gone. With a reverse mortgage you borrow against the equity in your home. But unlike a regular home loan, you don’t have to make monthly payments or worry about paying off the mortgage. Instead, the lender pays you. Generally, the payments continue for the rest of your life or until you move. Then when you die or sell your house, you or your heirs pay back the loan plus interest, and keep any proceeds that remain. In no case will you have to cough up additional funds to pay off the loan. That’s the beauty of reverse mortgages: The lender takes the risk that you will live a long time or that the house may not appreciate at the expected rate. You pay for this transfer of risk, of course, which is why you’ll want to think carefully about this strategy and shop around for the best deal.
To qualify, you must be at least 62 and live in your home. The amount you get depends on your age, how much your house is worth, and current interest rates. The greatest cash amounts generally go to the oldest borrowers living in the homes of greatest value on loans with the lowest costs. Generally, you can expect to receive 30 to 75 percent of your property value, but some of the proceeds will have to be used to pay off any existing mortgages. The payments are not taxable and don’t affect Social Security benefits. Interest costs can be deducted when the house is sold.
When shopping, be sure to explore all of your options so you can decide which plan is best for you. And be sure to compare the costs and benefits offered by competing lenders. Some reverse mortgages let you take a lump sum all at once (great fodder for your retirement bucket!); others offer a line of credit so you can write a check whenever you need it. Some offer competitive interest rates and fees; others take advantage of the obscure nature of these instruments to gouge unsuspecting homeowners, in some cases even cutting themselves in on part of the future appreciation of the home. Some offer high credit limits; others, such as those offered through Fannie Mae (FNMA) have lower limits but may offer more attractive terms. Be sure to get counseling before signing onto one of these deals. Talk with loan counselors who understand the intricacies of these arrangements as well as your own advisors who understand your financial situation and will be watching out for your best interests.
The American Association of Retired Persons (AARP) has a wealth of information on reverse mortgages, including a forty-seven-page booklet called “Homemade Money.” To receive a free copy, send a self-addressed postcard to AARP Home Equity Information Center, 601 E Street NW, Washington, D.C. 20049.
Borrowing Against Your Children’s Inheritance
When you take out a reverse mortgage, you are essentially borrowing against your children’s inheritance, so why not keep the financing within the family? You’d need a lawyer to set this up, but if you take out a reverse mortgage with one of your children, your offspring would pay you a fixed sum equal to a certain percentage of the equity in your home. You get the cash, your child gets certain tax benefits, and you’ll all save high lender’s fees.
With a sale leaseback you sell your house to an investor (maybe one of your kids?), who immediately rents it back to you on a long-term (often lifetime) lease. Unlike a reverse mortgage in which you retain the title to the house, a sale leaseback is an outright sale. You receive a down payment plus regular monthly payments. Sale leaseback contracts can be written a variety of ways, but generally the new owner takes over expenses such as taxes, repairs, and insurance. These transactions are complicated and have significant tax implications, so be sure to consult a professional advisor, even if (especially if) you are keeping the deal within the family.
Rent Out Part of Your House
Not all methods for obtaining income from your home have to involve complicated rules and fine print. You could simply rent out a room or two to a student or couple—maybe to another retiree who decided to sell her house and rent—and receive several hundred dollars a month in rent. You’ll want to be careful when selecting your tenant, of course, since you’ll be living under the same roof. Before placing an ad in the paper or posting a notice on a public bulletin board, ask among your circle of friends and acquaintances if anyone is looking for a place to live. By choosing someone you’re compatible with, you may get the additional bonus of companionship, which can be nice if you live alone. With a tenant or “roommate,” you can both watch out for each other at the same time you’re providing economic benefit to one another.
REAL ESTATE AS AN INVESTMENT
Once you’ve decided what to do about your primary residence, you may want to expand your investment in real estate to take advantage of its appreciation potential, tax benefits, and even current income. As noted earlier, real estate provides a good hedge against inflation, since real estate prices tend to rise when inflation is rising. So if your asset allocation plan calls for all of your assets to be divided among stocks, bonds, and cash, you may also want to consider allocating a portion—say 5 to 10 percent—to real estate in case inflation rears its ugly head again, as it did in the late 1970s. Even without the threat of inflation, real estate can be a good long-term investment, primarily because it allows you to use leverage to get a bigger bang for your buck. For example, if you buy a $200,000 property and put $20,000 down, and if the property appreciates 10 percent to $220,000, you have just doubled your investment. There are drawbacks to real estate, of course—leverage being one of them. You could lose your entire investment and more if the property declines in value. However, if you’re careful and know what you’re doing, real estate may have a place in your overall investment portfolio.
Ownership of Income Property
You know those repairs we said your landlord would make if you decide to sell your house and rent? Well, you’ll get to do those repairs for someone else if you decide to become a landlord and invest part of your savings in income property such as apartments, duplexes, condos, or a single-family residence that you rent out to somebody else. Why in the world would you want to do that? Because rent can be good income. And depending on the location of the property and what the rental market looks like, it can be a source of constantly rising income. If rents are going up by, say, 3 to 5 percent a year, you have a built-in inflation hedge to cover higher expenses in retirement. And the whole time you’re collecting rent from your tenants, you’ re holding onto a property that has a good chance of increasing in value. Not only that, but there are tax benefits to being a landlord.
However, there are substantial drawbacks to owning income property too, and those repairs we just talked about are not the worst of it. You have to find the right tenants and hope they don’t trash the place. The property could sit vacant for a month or two (or more) while you fix it up or find new tenants; meanwhile you’re missing out on the rental income for those months. The property may not rise in value as much as you had hoped, so that after paying all of the expenses (mortgage interest, insurance, property taxes, etc.), you could end up breaking even or losing money.
But you decide. Some former landlords swear they’ll never do it again. Others find the business of renting property highly lucrative and even fun. Just be sure you know what you’re getting into. Take the time to understand the real estate laws in your state, become familiar with the real estate rental market in your area, and be prepared to devote considerable time and attention to the endeavor. Unlike stocks, where somebody else is running the company you are investing in, real estate is a high-maintenance investment—and we mean that quite literally.
Real Estate Investment Trusts (REITs)
One way you can avoid getting calls in the middle of the night about broken water pipes is to invest in income property through a real estate investment trust, or REIT. A REIT works like a mutual fund, where investors pool their money and professional portfolio managers buy a collection of real estate investments. Some REITs buy properties such as apartments, office buildings, shopping centers, and hotels. Others invest in mortgage loans. A few are hybrid REITs, investing in a combination of properties and mortgages. REITs tend to pay relatively high dividends, making them good income investments. And since they trade on major exchanges, they can be liquidated at any time. Choose a REIT as you would a mutual fund: Look at the underlying assets and the track record of the portfolio manager.
Set for Life, Financial Peace for
People Over 50 by Bambi Holzer with Elaine Floyd. Copyright © 1999 by
Bambi Holzer. Excerpted by arrangement with John Wiley & Sons, Inc.
$10.95. Available in local bookstores or from online booksellers or call
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