Money & Policy

Big Retirement House: a Trip to the Poorhouse?

Do the math before you commit to moving into a luxury home 

(This article appeared previously on MarketWatch.com.) 

Once you’ve paid for your house, how much will it cost you?

This is a crucial issue for anyone looking ahead to retirement. The more expensive your home, the more of a drain it’ll likely be in terms of property taxes, maintenance, homeowners insurance and more.
Suppose you own a home that, in addition to any mortgage payment, costs $1,000 a month. You then get a fat pay raise, prompting you to trade up to a larger house, which has double the monthly expenses.
Result: If you stay in the larger home during retirement, you’ll need to come up with $2,000 a month, equal to $24,000 a year. Based on a 4 percent annual portfolio withdrawal rate, that would mean $600,000 in retirement savings just to pay your housing costs, versus $300,000 for the smaller home.

(MORE: How to Lower Your Property Taxes)

“I’ve always been an advocate of modest homes,” says Charles Farrell, chief executive of Denver’s Northstar Investment Advisors and author of Your Money Ratios. A large house, he says, “means higher costs in retirement and it makes it more difficult to save while you’re working.”
The True Cost of Home Ownership
Whatever price you pay for a house, it’ll often end up costing you at least 2½ times as much over the long term, Farrell reckons. Say you buy a $500,000 home, put down $100,000 and borrow the other $400,000.
You’ll pay back the $400,000 with that portion of every mortgage payment that goes toward principal. In addition, you might cough up another $250,000 or so in interest, even after figuring in the tax deduction. This assumes a 4.5 percent, 30-year fixed-rate mortgage and a 25 percent federal income-tax bracket. Add that to the purchase price and you’re up to $750,000.
On top of that, Farrell figures the house might cost $20,000 to $25,000 a year, between property taxes, insurance, maintenance and occasional improvements. To generate that income in retirement, you might need $500,000 in savings, and probably more once you figure in the taxes on any investment gains. That brings the total tab to $1.25 million, or 2½ times the purchase price.

(MORE: Homeowner's Insurance Discounts After 50)

Farrell’s estimate for housing costs might strike some readers as high. It’s easy enough to get a handle on property taxes and insurance. Annual property taxes typically run 1 percent to 2 percent of a home’s value, while insurance might equal 0.5 percent.
It’s harder to get a grip on maintenance and occasional improvements, in part because homeowners may go a few years without any major expenses, but then fork over hefty sums for a new roof or a kitchen remodeling. These projects, which are often necessary just to maintain a property’s value, are easy to dismiss as onetime expenses — and yet they seem to roll around with fair frequency.
Whether you think Farrell’s numbers are too low or too high, he makes an important point: High housing costs can make it tough to retire, because they crimp our ability to save while we’re working and increase the nest egg we’ll need to retire in comfort.
Indeed, Farrell advises folks to buy homes that cost no more than 2 to 2½ times their gross income. That’s doable in many parts of the country, but it’s almost impossible if you live in a major city on the East or West Coast.
“The coasts are tough,” Farrell concedes. “I know people aren’t happy with those figures, but they’re prudent.”
Two Lessons
This issue of housing costs brings together two themes I often harp on. First, you’ll have more financial breathing room — and less financial stress — if you hold down your fixed living costs, including mortgage or rent, car payments, property taxes, insurance premiums and utilities. One rule of thumb: Try to keep these costs to 50 percent or less of your pretax income. That way, if you’re laid off, you know you can get by on half of your old salary.
Second, temporarily cutting back spending is a key financial tool, especially for retirees faced with rough financial markets. The lower your fixed living costs, the more flexibility you’ll have.
Still tempted to buy the big home? Keep Farrell’s math in mind.
“If you’re going to buy an $800,000 house, the real cost is close to $2 million,” he says. “You have to ask yourself whether you can afford it. It’s a tough one to fight against, because people still have this perception that a home is a good investment. But most of the time, it’s a money pit.”

Jonathan Clements is a MarketWatch contributor and a columnist for the Wall Street Journal Sunday Journal. 

Jonathan Clements
By Jonathan Clements
Jonathan Clements is the founder and editor of HumbleDollar. He has written eight personal finance books, including From Here to Financial Happiness (to be published in September 2018) and How to Think About Money, and contributed to five others. He sits on the advisory board and investment committee of Creative Planning, one of the country’s largest independent financial advisors. He spent almost 20 years at The Wall Street Journal, where he was the newspaper’s personal finance columnist, and then worked for six years at Citigroup, where he was director of financial education for Citi Personal Wealth Management, before returning to the Journal for an additional 15-month stint as a columnist. Follow Jonathan on Twitter @ClementsMoney

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