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Utilizing Home Equity in Retirement, for the “Yacht-less”

Introduction – A Brooklyn healthcare worker and artist

Utilizing Home Equity in Retirement, for the “Yacht-less”

Let me tell you about a healthcare worker that purchased a three-level walkup in Boerum Hill, Brooklyn in the early 1980s at a cost of $35,000. She wanted an easy commute, was prepared to “deal” with the neighborhood, and she wanted to own and collect some passive income. The property is now worth $4.5 million (that is a CAGR of 14.0%). In the same neighborhood, a couple purchased a similar property primarily so they could afford an art studio, they also experienced enormous growth in their residential property value. In New York City, and no doubt other cities around the country, there are many property owners entering retirement with significant home equity wealth. Your retirement portfolio can be made up of the following - residential equity, deferred tax investment accounts (401(k), IRA, SEP), tax-free investment accounts (Roth IRA), Social Security, Retirement account, an annuity, direct investments, insurance, cash, a rental property, and business interest/s. However, according to the 2011 U.S. Census data the average American couple at age 65, home equity makes up more than two-thirds of their total wealth, and for most Americans, home equity and Social Security benefits represent the two biggest assets on the household balance sheet.

What are your options for utilizing your home equity in retirement?

At the outset let me say for our Brooklyn homeowners, the above is a good problem! Before we consider the options available to retirees with significant home equity capital gain, we need to ask three questions to understand their desired housing situation in retirement:

  1. Where do you want to live in retirement?
  2. How long do you want to live in your current home?
  3. Do you want to leave your home to your heirs?

Let us assume our Brooklyn client answers these questions as follows:

  1. They are in good health and want to live in their city residence.
  2. They wish to “stay-in-place” and have no plan to relocate in retirement.
  3. Leaving a legacy is important to them, but sufficient income to live independently and with dignity in retirement is their priority.
  4. Capital gains tax on a sale would be significant and something they wish to minimize.

What are their options?

There are several strategies available to the property owner to access their home equity and meet their retirement goals, as follows:

  1. Selling the home, downsizing and relocate;
  2. Entering into a sale-leaseback arrangement;
  3. Converting the residence into a rental property, and relocate;
  4. Converting the residence into a part rental property, and remain in place;
  5. Borrow funds secured by the property;
  6. Reverse mortgage.

Options a) and b) trigger a taxable event and you would be paying capital gains tax on the Proceeds less your basis and the $500,000 exclusion for MFJ[1]. Option c) does not trigger a taxable event however our client does not want to relocate. Option d) and e) meet their needs, i.e. to “stay-in-place” with no capital gain triggered. With regards Option e) I know of a circumstance where an elderly couple wished to stay in their upper east side co-op, however, monthly maintenance costs were depleting their savings. In that situation, a family friend provided a loan with a lien against the property on their passing so they could stay in place and leave the apartment to their heirs. We know things do not always go according to plan, so it is always wise to consider alternatives. Two-thirds of 65-year-olds will never enter a nursing home, but for those that do the expenses can be significant[2]. If our client selects option d) it enables greater deductibility of State and Local Taxes (SALT) as a proportion of the property is for rental purposes and the SALT tax limit would not apply for the rental portion of the property and would be claimed on their Schedule E. Furthermore, if circumstance arise that result in relocation, for health or other reasons, the property can then be a 100% rental property. In this case, the carrying costs would be minimal due to the significant owner equity and therefore the now 100% rental property would provide a significant source of household income, approximately $22,500 per month, assuming a 6% yield ($4.5million at 6% = $22,500 per month) and 100% of SALT taxes would be tax deductible on Schedule E and the property tax basis would step-up to market value when inherited by their heirs. Of interest, the G. W. Bush Administration considered elimination the tax basis step-up for inherited property, who knows what will happen in the future, one plans with what one knows.

Michael K. Stein discussed the three stages of retirement in his 1998 book[3] as - the Go-Go years, the Slow-Go years and the No-Go years. The transition to retirement is unlike any other in our life, earlier life transitions are in the main tangible - college to the workplace and a career, family, purchasing your first home, the kids leave for college, career change and relocations. Transitioning to retirement and the spending of our wealth is a whole new experience for more and more people, the proportion of the U.S. population over the age of 75 is projected to double in the next 20 years from 23% in 2020 to 45% in 2040 [4].

Conclusion – Focus on what you can control.

Each and everyone entering retirement has a unique set of circumstances requiring careful evaluation. I always conclude with a focus on the things you can control and impact your investing and financial planning experience. When evaluation your retirement financial plan be sure to ensure:

  1. the financial plan fits your needs and your risk tolerance today and is flexible if circumstances change.
  2. the financial plan is structure across dimensions of return.
  3. the plan investments are diversified.
  4. expenses and taxes are known and managed.
  5. the plan will keep you disciplined through market swings and dips.
  6. You share your plan with family and loved ones.

This is a big topic; you are about to commence your “Go-Go years” Your investments portfolio is likely at a lifetime peak in value. Managing your portfolio during retirement to ensure you have sufficient retirement income to maintain your independence and dignity is the bottom line.

Any questions?

I hope you found this blog helpful and that it steers you to the best option for your needs. Each week I allocate time to answering questions I receive on my blogs, so if you have questions, please let me know at This email address is being protected from spambots. You need JavaScript enabled to view it.. I'll do my best to get back to you within 48 hours.   If you have a Facebook or LinkedIn account, you can click on the little "Facebook" or “LinkedIn” icon and share this article. That way more people will be able to find it and hopefully, more people will benefit.

[1] Long term federal capital gains tax rates – Married Filing Jointly (MFJ) 15% for taxable income <$425,800, and 20% if > <$425,800, plus State tax 8.8% (NY), and NY City tax 5%.

[2] Amy Finkelstein “The Market for Long Term Care” in The Future of Life-Cycle Saving and /Investing.

[3] “The Prosperous Retirement: Guide to the New Reality”

[4] Center for Retirement Research at Boston College, Source: U.S. Census Bureau (2017)

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