How to Tell if You Should Downsize in Retirement

Moving to a less costly home doesn’t always improve your retirement finances.

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The housing crisis may have changed how people perceive home equity's role in funding a comfortable retirement. But downsizing can still be a viable way to increase your savings cushion significantly. Before you put up the for-sale sign, answer these questions to make sure this is the right step for you to take:

How much does the alternative cost? First and foremost, you need to make sure you are actually going to save money by moving to a different home. I know of many people who planned to downsize, only to buy an even bigger house once they get into the hoopla of house hunting. Also factor in maintenance costs of the home, property taxes going forward, and other general upkeep. Don't ever try to downsize only to spend just as much, or even worse, more than your original housing costs.

How will moving to a different house affect your lifestyle? Where you live makes a big difference in how much you need to spend. Some people opt to move to a different city all together, but that’s not the best choice for everyone. Consider whether you will be moving closer or farther away from your family. If your family is close by, will your new place have room for your grandkids to stay over? If you love hosting Thanksgiving, will a big enough dining room fit? Also think about whether you want your existing friends to be a part of your retirement years. Money is important, but so is everything else. Moving is a big decision, so think it through carefully. It would be very costly to move back if you regret the decision to relocate.

Will you be responsible with a sudden influx of money? Spending money is very easy, which is why so many people end up in poverty even after a significant inheritance. If you cash out your home and move into a much smaller one, will you be able to make that extra cash last, or will you blow it on some expensive toys? One way to mitigate the temptation is to have a plan for how the money will be invested before you receive the cash. It’s much easier to think clearly while you still cannot access the lump sum.

Are there taxes to worry about? Selling your primary home for more than the real estate capital gains tax exclusion may seem unrealistic. But if you stay in the same home for a few decades, this scenario becomes a real possibility. Before you blindly sell your home, figure out how much money you are actually netting, factoring in costs such as moving, taxes, and realtor commissions. Some people have the intention to downsize, only to end up paying more for a smaller home because the tax man takes a huge bite of the gains on an older home. Don’t be one of those people.

Are there other ways to extract equity from your home? Reverse mortgages can be costly, but it may make sense for you because you can avoid losing your home as long as you are alive. Some parents may also be able to work out a deal with their kids where the parents sell their home to the kids, but still live there. If you don’t want to part with your current house, explore possibilities that will allow you to stay in your home throughout retirement.

Downsizing is a great idea for many people hoping to make their retirement more financially secure. But make sure you understand how a less costly home will affect your life before you take the plunge.

David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.