Be on the Upside of Downsizing
Planning ahead is the key to making the most of your move to something smaller.
Whether you’re an empty nester left with too much house or want to take advantage of the home equity you’ve built, downsizing can be a sensible choice. But picking up and moving, only if it’s just around the corner, has implications. Not only for your finances, but for your lifestyle and happiness too.
The answer? Have a plan before you list.
When downsizing makes sense
There are many reasons why downsizing can be the right decision, some financial, some practical.
One thing’s for certain. If you’ve owned a home for any length of time in Metro Vancouver, you’ve seen a dramatic jump in its value. Choosing a smaller dwelling or relocating to a less expensive neighbourhood lets you unlock that equity. Best of all, when you sell your principal residence, any gain is generally tax-free.
Here are a few of the ways downsizing can pay off:
- Pay down debt. Wind down expensive consumer debt or mortgage on an investment property.
- Help out family members. Give your children and grandchildren a hand up with a down payment, or put money toward their educational expenses. Help out your aging parents with renovations and upgrades that let them stay at home longer.
- Free your lifestyle. Live life on your terms – travelling, pursuing hobbies, volunteering or enjoying luxuries you couldn’t before.
- Switch to low maintenance living. When you no longer need the space, a smaller abode can mean less maintenance and worry.
- Get a head start on retirement. Your new-found financial flexibility might allow you to move up your retirement date by boosting your savings, income and size of your legacy.
Whatever your motives for downsizing, it’s critical not to rush into it.
Think about your priorities. Is your move all about convenience or is it more important to have a home that’s able to accommodate your physical needs as you age? What about being closer to family, or having a little extra space for the grandkids? If you make a change for the wrong reasons, chances are you’ll regret your decision, even to the point of going through the costly process of moving again.
For all the potential upside, downsizing has its challenges. A common pitfall? Overestimating the financial benefit.
The kind of home you buy and where it’s located is key to the amount of profit you’ll have left in the end. For example, if you’re trading a house in the suburbs for a luxury condominium in the heart of the city, there may be little, if any, margin in your favour.
As well, don’t ignore the costs connected to buying and selling property like realtor commissions, legal and appraisal fees, moving expenses and the property transfer tax. With sales activity cooling off from a fever pitch and buyers feeling less hurried, selling your property quickly for top dollar in today’s market might require spending a little on repairs, updates or staging to enhance its appeal.
If you’re considering a strata property – think townhouse or condominium – you’ll have to factor monthly maintenance fees and special assessments into the equation. Living in a building with extras like a pool or gym can mean paying out more than you did to maintain your old residence.
Strata corporations typically have restrictions which will affect you, from bans on pets and barbecues, to strict rules on the type of window coverings you have or what you can store on your balcony. And, because you’ll be sharing walls and common areas of the property with others, more convenience can go hand-in-hand with a loss of privacy.
If you’re moving out of the area, ensure your new neighbourhood has the services and amenities you need. Above all, ask yourself if you’re emotionally ready to go. It can be surprisingly difficult to say goodbye to your neighbours, community and a home filled with happy memories.
New Reporting Rules When Selling Your Principal Residence
Among the housing-related measures announced earlier this month by the federal government was a change which could affect you if you’re planning to sell your home. Starting with the 2016 tax year, the Canada Revenue Agency will require you to report details of the sale of your principal residence on Schedule 3 of your general income tax return in order to claim the principal residence exemption.
Your real estate windfall and your financial plan
Liberating your home equity opens up new possibilities. That makes it an opportune time to re-examine key parts of your financial life.
Take a fresh look at your budget. Your cash flow situation will likely change – perhaps dramatically so – once you downsize. Odds are you’ll have more capital to generate extra income from each month. At the same time, look at your spending. Do you have some high-priced purchases in mind? What about travel? While you may save money on house maintenance with a smaller space, there could be new expenses like condo fees to budget for.
Decide whether to invest differently. Once you sell, it’s a good bet you’ll see more of your net worth shift into financial assets, particularly if you rent. This may affect how you allocate capital between equity, fixed income and cash. You’ll want your investment portfolio to spin off enough cash to cover expenses your paycheques, pensions, annuities or rental income won’t adequately meet. At the same time, you’ll need the right blend of growth and safety to help your savings stay ahead of inflation while coping with the volatility of financial markets.
Assess the income tax impact. Downsizing can create an unwanted consequence: higher taxes. Having more funds to invest can hike your income, perhaps enough to push you into a higher tax bracket. In turn, you risk a clawback of income-tested government benefits like OAS, and a possible loss of tax credits.
If you have unused contribution room available, one strategy to lessen the tax impact is to channel some of your real estate profits to your RRSP or TFSA to reduce taxes now and shelter more of your capital going forward. If you’ve already built a sizeable RRSP, assess whether it’s worthwhile to start withdrawing from your plan early to level out your income before mandatory RRIF withdrawals add to your taxable income. Want to create more tax-efficient cash flow? Prescribed annuities and qualifying dividend investments are options.
Don’t forget to ask your advisor to explain the tax-saving benefits of life insurance. Not only will the right policy protect your family’s financial security, it can also help you defer tax and preserve more of your future estate for your heirs.
Review your estate plan. If selling your home will affect the size or nature of gifts and bequests for your children, relatives or charitable organizations, it’s time to revisit your will and estate plan.
A financial windfall can complicate matters both for you and those you intend to pass your wealth to, now, or through your will. That’s why in some situations setting up a trust is advantageous. Say, for example, you don’t want to give a large cash gift outright to a young adult. A trust lets you structure the size and timing of distributions. Plus, when properly arranged, there’s the potential to split income with beneficiaries to save tax, as well as minimize the probate fees your estate will eventually face.
Should You Rent Instead?
Once you sell, you can always rent a home instead of buying another one. But should you? Beyond costing out each option, how you answer some key questions can help you decide.
- Do you still want to participate in real estate as an investment? Viewing your home as a vehicle to grow your wealth, and not simply a place to live, argues for repurchase. On the other hand, as a renter you won’t bear the brunt of price corrections in the housing market when they strike.
- Will you have enough cash to live your dreams? Buying another property can soak up the bulk of the proceeds from downsizing. An advantage of renting is it leaves more capital free to do with as you please, whether investing for income or spending to support your lifestyle.
- How much freedom do you want? If you’re planning on spending winters away, or don’t want to deal with maintenance hassles or major repairs, renting can be the way to go. You also have the freedom to move when your lease is up, without the costs or risks surrounding resale. However, you might not have much say over things you’re used to controlling, whether it’s the appliances you’re using, renovations or keeping pets.
- Are you unsure about your planned move? If you’re wondering whether a major change like living in a condominium or moving to a smaller town is right for you, renting lets you ‘test drive’ your proposed lifestyle first, before making a long-term commitment.
Turn to us for smart advice
At BlueShore Financial we’re committed to helping you make your downsizing dream a success. It begins by working with one of our skilled advisors to put together the right plan first, before you list.
Ready to get started? Contact us today to learn more.