Things to keep in mind before downsizing your home

A small dog inside a cardboard moving box

By Luke Kidd

In our experience working with retirees, we often see clients considering whether they should sell their home and move somewhere more suitable for their needs. For example, couples who find themselves as “empty nesters” may no longer need a large 5-bedroom home and would perfer a smaller townhouse that is easier to maintain. Some may want to move from a multi-story home to one that is at ground level as they face mobility issues. Others may look at moving to a retirement or lifestyle village to enjoy the services and community engagement they offer.

There are financial reasons to downsize as well; for most retirees, the family home (or principal place of residence) is one of their largest financial assets and downsizing can allow retirees to access some of the value of their home and use it to generate income or fund other purchases.

While downsizing can present a lot of these upsides, it is important to also consider the risks and potential downsides before making a change.

Access to capital

Retirees may find themselves drawing down on their liquid assets in retirement such as bank accounts, their superannuation fund or account-based pension. The risk of running out of liquidity means that retirees may have to look at using a debt facility to fund future purchases, such as credit cards or reverse mortgages. Taking out large amounts of debt in retirement can be risky as the effects of compounding interest can erode the amount of available capital, particularly over the long term.

As an alternative, retirees can consider downsizing to access some of the value of their home to meet future expenses. To help achieve this, Australians over age 60 can make a one-off downsizer contribution to help invest these proceeds in a tax effective way via superannuation (subject to eligibility criteria and legislative limits).

Example: Allan, age 76 is drawing down on his account-based pension balance and is looking for a simplified lifestyle. He sells his home of 25 years for $1m and with this money purchases a townhouse nearby for $700k. The $300k remaining is contributed to super as a downsizer contribution and with this he sets up a tax-free retirement income stream.

Centrelink treatment

Normally the family home is exempt from Centrelink means testing, so retirees receiving a full or partial Centrelink or DVA age pension need to be mindful of how downsizing their home may affect their income support payments.

The cash proceeds from the sale of the former home are exempt from the age pension assets test for up to 12 months if the pensioner intends to purchase a new home with this money. However, the cash proceeds will be subject to deeming for the income test from day 1 and increase their assessable income. If the pensioner realises some of the equity of their home to fund their retirement as per the example above, these funds will form part of the Centrelink income and assets test.

Age pension recipients can risk a reduction in their benefits depending on their circumstances. And these trade-offs should be considered as part of a careful planning process.

Example: Before Allan downsized his home, he had total assessable assets of $280k and was receiving a full age pension. After downsizing and investing $300k in super, his assessable assets increased to $580k. His age pension benefits reduce significantly from $987.60 to $87.60 per fortnight. This loss of $900/fortnight needs to be made up from his investment to maintain the same standard of living.

Retirement Villages

Often retirees look to downsize to a retirement or lifestyle village, attracted by the offer of ongoing home maintenance, access to leisure activities, community engagement and even access to aged care services. The various forms of tenure, fees and contractual agreements are beyond the scope of this article. However, it is important to understand that these features and benefits are not without cost.

As noted above, the family home is often a retiree’s most significant asset. Owning a freehold property allows retirees to benefit from the long term growth in the real estate market. However, we often see that when someone enters a retirement village arrangement, the ongoing costs and departure fees eat into their investment, and when they sell, they often receive less than they initially put in. Therefore they have missed out on the potential growth in the market had they owned the property outright. This opportunity cost can have significant implications for the client’s ability to fund residential aged care and can also leave less money for the client’s estate.