By Robert Powell
TOP 5 IN REAL ESTATE NETWORK, October, 2009—(MCT)-When it comes to planning for retirement, there are many, many questions to answer. But to Anna Rappaport there are just three that matter and perhaps one that doesn’t get enough attention: When should you retire? When should you collect Social Security? And what should you do about the equity in your home?
If you get the answers to those questions right, you’ve pretty much got retirement right, according to Rappaport, a former president of the Society of Actuaries as well a president of a Chicago consulting firm bearing her name.
Now, there’s plenty of information about the first two questions but not so much about the third. And that’s the one that people really need to get right now, especially given the findings of the SOA’s recent work on the subject. Here’s a snapshot of what Rappaport and her colleagues found – information that can help both you and your clients:
What Should You Do With the Equity in Your Home?
The equity in your home represents a big part of your wealth. If you’re married, your non-financial assets — mostly the equity in your house — represent about 70 percent of your total assets, according to a 2009 Society of Actuaries report “Segmenting the Middle Market: Retirement Risks and Solutions.”
What’s more, the report noted the median value of financial assets is less than 1.5 times median income — $75,000 — for the majority of middle-class households and that the median value of financial assets is just three times median income — $132,000 — for the vast majority of affluent households.
There are caveats in the 70 percent figure, though. The SOA report excluded the value of Social Security and traditional pension plan benefits, which if included would reduce the percent home equity represents to total assets. And the percent is based on analysis of the 2004 Survey of Consumer Finances. Things have certainly changed since then.
Still, the number is relevant because the equity in your home — downturn or not — is still “a very significant retirement asset and options related to choice and financing of housing are important considerations for retirement planning,” according to “Overview of Housing Wealth, Options, and Spending Issues in Retirement,” a just-released SOA paper co-authored by Rappaport.
Rappaport said that housing costs currently represents about 35 percent of a pre-retiree’s budget. And that means housing equity, as a percent of total assets, is perhaps more than twice what it should be.
Software Fails to Consider Housing Wealth
But even though the equity in your home is a big deal, the SOA’s study finds that much is lacking when it comes to helping average Americans figure out what role housing wealth should play in financing retirement. “… Although housing wealth was extremely important to middle class Americans, it did not seem to represent a primary consideration as they engaged in retirement planning,” Rappaport wrote. “In fact, many planning tools do not consider it explicitly, leaving a hole in advice that could be provided to middle income Americans.”
Indeed, most retirement planning software programs don’t consider housing wealth, and of the few that do it’s apparent that there’s no agreed-upon standard for doing so. Rappaport wrote. “The software tools that did consider housing wealth approached it from a wide range of methodology,” she wrote.
And users of these sorts of tools, especially those who have much of their wealth in housing, should see all sorts of red flags and disclaimers when the software doesn’t address housing wealth. (By the way, most calculators of this sort don’t include the new present value of your Social Security benefits either and that’s something that should be noted as well.)
How to Use Housing Wealth to Finance Retirement
So what are people who have 70 percent of their wealth tied up in their home to do? There are a number of options for using housing value to provide for retirement needs, according to Rappaport. But it should be noted that there is not a consensus on the best course of action.
“Further research needs to be done to define the options, identify the trade-offs, provide a framework for analysis and help individuals make decisions,” Rappaport wrote. And, as with most things financial, she said the ultimate best course of action will also depend on “individual preferences and circumstances.”
That said, here are the options you have to unlock the equity in your home:
—Pay off the mortgage, if possible, to reduce overall expenses
—Sell and downsize to a smaller home, freeing up funds for investment or annuity purchase
—Sell your home, invest the proceeds and then rent
—Secure a home equity loan or secondary mortgage on the house
—Get a reverse mortgage
—Rent out extra rooms
—Rent out your primary residence and live elsewhere at a lower cost
—Keep the house mortgage-free, and let its value serve as an emergency fund if needed
Not all of those options are viable for your retirement plan. And some of the options aren’t quite ready for prime time, just yet. For instance, “reverse mortgages may offer significant income potential to some households, but at relatively high cost and risk,” Rappaport wrote. “Furthermore, they may help older households remain in their homes, but they limit future housing choices and are presented as a last resort option by some financial planners.”
The Bottom Line
All this means that there’s much more work to be done, said the SOA report. Researchers and advisers need to put finger to calculator and keyboard to try to figure out what portion of their clients’ personal wealth should be spent on housing and whether it should be scaled back.
What’s more, researchers need to work on models that show the trade-offs between lower spending on housing and more savings put into financial investments vs. what we have now, higher spending on housing and less savings in financial assets. And think-tank types need to “work towards a consensus around accepted methods” to help Americans better understand how to incorporate housing wealth in their retirement plan.
(c) 2009, MarketWatch.com Inc.