Don't rely on home equity in retirement

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A recent report from Statistics Canada says home equity makes an important contribution to retirement income. However, retirement planners say it is not necessarily a sign of financial wellbeing.

The StatsCan study took into account the economic benefit of owning a home, as opposed to renting. The value of this benefit, applied to households headed by individuals in the 60 to 69 age group, increased their incomes by $5,500 or 10% and by $5,400, or 12% for those ages 70 and over.

However, it's a sound retirement plan—not home equity—that should be the cornerstone of retirement income, says Patricia Domingo, an investment retirement planner with RBC.

"As a financial planner, I don't come across many clients who are in a position where they have to tap into their home equity when they retire, because they plan in advance and they have built up a good net worth, both with their house as well as their investable assets," says Domingo.

Keith Pangretitsch, director, national sales with Russell Investments, agrees. Not many retirees depend on home equity for income.

"At the moment most people who are retiring have defined benefit plans. When you have the stability of that, people don't have to access their home for capital."

He says a future trend may be developing, though. "We think it's going to change and people are going to have to use home equity as part of their retirement plans. Especially with the way the markets have performed and how housing has appreciated, we suspect that housing will become a bigger part of it."

One of the ways retirees capitalize on home equity is to take out a reverse mortgage and use that money to generate a tax-efficient income stream. Domingo says that it's usually under stressful circumstances. "It's not for enjoyment purposes, it is because of the financial stress more than anything."

An income thus created doesn't warrant aggressive tax planning. "Typically, their taxable income is very low. There isn't so much need to aggressively tax plan," says Domingo.

"You want to view your home, particularly your principal residence, as a shelter rather than your retirement asset," she says.

Unless, of course, an individual's post-retirement needs dictate downsizing of their principal residence and their current home's value has appreciated significantly.

"If they plan on downsizing their home, then we take into account the use of the excess for retirement income while building a financial plan," says Domingo.

Most retirees eventually have to go into an assisted living situation, which is another reason why they can't count on their home equity as a source of income. "A lot of the time it's the proceeds from the sale of their home that will fund that," she says.

It is not uncommon for many retirees to take out small loans against their home equity to fund renovations or use it to make down payments on additional property—a retirement home perhaps.

The results of the StatsCan study come as particularly good news for retirees ages 70 and over. It reports for households in this group, whose household income was ranked in the bottom 20%, home ownership raised incomes by about $4,200 (20%), on average. For those in the top 20%, income increased by $10,400, or a modest 7% in proportional terms.

(07/30/2010)