There are a lot of opinions out there about how much you can pull out of retirement and not run out of money before you die. One of those popular ideas that govern how much you can pull out safely is the 4% rule. Meaning, you can only withdraw 4% of your assets each year, adjusting it for inflation. This is so that you will (most likely) never run out of money. But, do you include as an asset the equity in your home?
That’s a great question for sure. Because surely, someone who has a $500,000 home that’s paid off is in a much better situation than someone who has little equity in their home, correct? While that may be true, that they are in a much better situation, the general rule of thumb is, no, you shouldn’t count the equity in your home when pulling out your 4% if you choose to use this withdrawal method.
Why Can’t I Use The Equity In My Home?
I know many view their home their most valuable asset. So, it seems natural to consider this asset in retirement. But is it wise to believe this when it comes to accessing money in retirement? While it may be tempting to consider the home as an option, it’s important to only consider “liquid” assets when you’re planning on pulling money out for your monthly needs.
Certainly, everyone’s situation is different and you may very well benefit from a financial advisor before you begin the journey of withdrawing funds and supporting your retirement lifestyle, but it’s safer to only consider assets that are liquid such as your 401(k), 403(b), IRAs, and other retirement accounts including cash equivalents.
The main reason, of course, of why you shouldn’t consider this equity source is that you’re still living in the home. And unless you have a very knowledgeable resource about accessing that cash via a reverse mortgage (not my favorite and I wouldn’t suggest unless it was an extreme situation), it’s best to not use this figure in your calculation.
Thus, if you have a million-dollar portfolio and you have that home equity valued at $300,000, you should still only pull out 4% of the million bucks (not the 300k). So, in this case, you can plan on using $40,000.
There Are Reasons
Yes, there are a few reasons not to use your home equity when planning for retirement withdrawals. The first, as we’ve said, is that you should only use “liquid” assets since you’ll be withdrawing from them on a yearly basis.
It’s very hard to take out monthly withdrawals from your home equity. Unless you’re selling your home, that equity is locked up.
Additionally, the studies that have been done surrounding this topic (withdrawing 4% initially and adjusting it for inflation each year) were done specifically NOT considering the equity in your home. They were based generally on stock market-like returns with a liquid portfolio. Their prediction was that your money “should” last you at least 30 years, often with a stock/bond ratio.
So, when figuring out this little detail, we’re using your investment worth, not your total net-worth. You may be worth 1.3 million bucks when accounting for the equity in your home, but if your portfolio is only worth $1 million (+300k home equity), were going to use that 1 million as our starting figure for withdrawals.
There Are Always Exceptions
Yep, there are exceptions to almost everything. Including your home. If you, however, decide to downgrade and move into a smaller home, you can then use the profit of the home in your calculation.
So, if you have that million-dollar portfolio, and you downgrade your home and it leaves a $300,000 profit, you now have $1,300,000 to pull from, which would start you out at $52,000 to use.
The money from this sale might be tax-free as well. If you are married, filing jointly, you can exclude up to $500,000 in gains from income taxes if you’ve lived in the home as a primary residence for 2 out of the last 5 year period. If you are a single individual you can exclude up to $250,000.
And this is certainly a technique of many individuals: sell their larger home in retirement and downsize, investing and using the profits to help fund their retirement. Many often move to cheaper areas as well or to states that offer zero state income taxes.
Reverse Mortgages
I’m not a fan of reverse mortgages but these are loans allowing you to tap into your home equity while still owning your home. There are certain age (and other) qualifications to qualify. There are also often certain expenses associated with reverse mortgages, but they certainly are an option if needed to help fund your retirement.
I would personally find an expert in this area if you’re considering this option. Be well informed when making this decision.
Be Careful With The Numbers
Although it may be a bit disappointing to hear that you shouldn’t include the equity in your home when figuring out your 4% withdrawal method, it will save you in the long run.
Remember, these studies surrounding this withdrawal method were done NOT including your home equity.
Plan accordingly and invest appropriately.
One thing you can do is get your home paid off! If you have a $1,500 home payment (not including taxes, etc) you’ll have much fewer expenses in retirement. The 4% withdrawal from your retirement accounts may then last much longer than you anticipated.
Not having housing expenses is a great thing! You may not even need the full 4% from your retirement accounts which should theoretically allow your money to last even longer.
Regardless, be aware of your numbers. It’s your future after all. One tool that I enjoy is Personal Capital retirement planner. It will help you keep track of your numbers. The more informed you are the more power you have.
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