Hidden risks for Canadians planning to downsize their retirement

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Moving costs

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It can be expensive to move and the transaction costs may surprise homeowners who have not done so in many years.

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Real estate commissions are paid by the seller and generally range from three per cent to six per cent of the selling price, depending on the province, the value of the home and other factors.

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Land transfer taxes and similar government fees to buy can range from one per cent to three per cent. Other miscellaneous costs such as legal fees and hiring movers have an impact as well, and there are unanticipated costs like new furniture or decorating, replacing appliances or minor maintenance.

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If a homeowner is planning a minor downsize, these costs can wipe out 10 per cent of your home value, so moving to a slightly less expensive home may not provide the hoped-for padding for retirement funding.

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Investing the proceeds

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If you downsize and suddenly have more money to invest, how you invest it matters. As the numbers get bigger and as the decumulation phase approaches or begins, some investors become more concerned about investment losses.

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Some retirees may put their investment risk tolerance to the test and find their comfort level with stocks is lower than it was when they were accumulating savings.

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As a result, a retirement plan should arguably rely on a lower future return than past returns, especially coming off a 13.6 per cent annualized return, including dividends in Canadian dollars, for the S&P 500 over the 10 years ending May 31.

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The nine per cent total return for the S&P/TSX capped composite index over that same period, while lagging United States stocks, has still been quite strong. I may be proven wrong in 10 years, but a North American-focused stock portfolio may not have double-digit returns looking back to today.

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Some retired investors risk becoming more motivated to try to time markets, moving in and out of stocks to try to protect their nest egg. In some cases, with the blessing of their advisers. It can be easier to appease a client than to push back and risk being occasionally wrong.

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And with more self-directed investors taking the helm of their portfolios, there may be less resistance to poor investment practices such as panic selling or chasing speculative investments.

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Emotional impact

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Downsizers may have to get rid of many years of accumulated personal effects, lose a backyard that kept them busy and find it more difficult to host family and friends.

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This makes the subsequent destination more important than the selling price of a home because all the money in the world may not matter if the emotional toll of a downsize is too high.

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This fear can lead some would-be sellers to never sell at all. This hesitancy can become overwhelming for some to the point where they never end up moving.

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It may be harder to move as you get older, too, and riskier if your home is not a safe place to age. That multi-level backsplit home might have been great to raise a family, but it can be dangerous as mobility begins to wane.

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U.S. tax implications

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The principal residence exemption in Canada generally shields a Canadian taxpayer from paying capital gains tax when they sell their home except for rare exceptions. U.S. citizens in Canada should be mindful of a potential tax trap when they sell their home.

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Americans are taxable on their worldwide income even when residing in Canada. Because Canadian tax rates are generally higher, and there is a foreign tax credit mechanism that avoids double taxation, there is typically little to no tax payable to the U.S. Internal Revenue Service. However, there are limits in the U.S. for the tax-free sale of a principal residence.