Trading Down: Can It Still Bankroll Your Retirement? .

Trading down to a smaller home is a retirement-planning staple. According to an April study by the Society of Actuaries, 20% of not-yet retirees say they plan to downsize after the last child leaves the nest.
By: M.P. MCQUEEN: wsj.com
But it is getting a lot harder to do, even for wealthier people.

A study by the Joint Center for Housing Studies at Harvard University, scheduled to be released on Monday, shows that while mobility has slowed across all age groups during the real estate bust, "mobility rates among seniors have posted the sharpest drop." Trade-downs in March comprised about 8% of total home sales, down from 12% in October 2008, the first year for which there are historical comparisons, according to the National Association of Realtors.

Why are pre-retirees staying put? The housing crash has pounded the higher end of the market, to which many 50- and 60-somethings have graduated. That has narrowed the price gaps between the upper and middle markets, meaning smaller homes aren't always much cheaper.

Making matters worse, people took an enormous amount of money out of their homes during the bubble—$358 billion in the peak year of 2005 alone, according to Goldman Sachs. So-called cash-out refinancings raised mortgage burdens sharply. That, combined with the price plunge, has wiped out trillions in home equity during the bust, making empty-nesters unable to trade down easily.

Other factors, such as job complications and dealing with adult children, are getting in the way, too.

"Unless they live in a megamansion, I haven't seen enough in savings" to justify trading down, says Steven Levey, a financial planner in Denver.

The logic of downsizing is simple. Middle-class Americans devote 20% to 50% of their budgets to housing costs, says John Henry Low, a fee-only financial planner in Pine Plains, N.Y. So people who reduce that figure significantly can improve their spending power accordingly.

Laurence Kotlikoff, an economist at Boston University and president of Economic Security Planning Inc., has developed financial-planning software to help people figure out how much they need to save for retirement. According to his calculator, which is available at www.esplanner.com/basic, a couple with a combined preretirement income of about $200,000 and living in a $900,000 paid-off home could boost their annual retirement spending from $40,314 to $47,289 just by trading down to a $450,000 home. That translates into a 17.3% higher living standard for the next 42 years, says Prof. Kotlikoff.

But Diane Saatchi, senior vice president at Saunders & Associates, a real-estate firm in Bridgehampton, N.Y., says downsizing nowadays "costs more than people have in mind." In her area, she says, total transaction costs easily exceed 10% to sell and buy simultaneously. When you add in the possibility of capital-gains taxes and moving costs, she says, "you need a big spread to make it worth the effort, and sellers often think they're going to get more than they can for the sale."

Kay Carpenter, 59 years old, and her husband Robert, 58, wanted to sell their 5,900-square-foot, seven-bedroom house in Windsor, Colo., and buy a home about half that size in Denver, where Mr. Carpenter currently commutes to his job as a hospital laboratory director.

But their current home, which they purchased for $810,000 in 2003, has received only one offer, for $575,000. "It is difficult to sell because it is a large home," Ms. Carpenter says. The couple, whose last child left the nest in 2005, are finding that they will have to spend about $450,000 for a suitable house. Throw in the transaction costs, and the financial benefit of downsizing basically disappears.

Trading down is a bit easier in some parts of the country, like the Chicago suburbs, where there is a mix of housing types and lower-tax communities co-exist with higher ones. "It's actually very typical, a classic scenario here," says Richard C. Gloor, a real-estate broker/owner in Oak Park, Ill. "More traditionally, people wait until the last kid is out of the house, five or 10 years. But now the last child is in college still and people say they don't need the space and especially don't need the taxes."

In pricey coastal cities like New York, Washington and San Francisco, desirable lower-cost housing is often hard to find in neighborhoods of upscale homes, real-estate experts say. In many affluent neighborhoods where aspiring retirees want to be, the supply of smaller homes is limited, due to zoning restrictions and high land prices. As a result, many homeowners find they would have to move a considerable distance to reduce their housing costs significantly.

Other hurdles beyond the slumping real-estate market are getting in empty-nesters' way, too. Many people of retirement age are still working, for example, and need to stay near their jobs, meaning out-of-state moves are out of the question. Some are in two-income households, complicating the decision to relocate even more.

What's more, adult children are becoming more of an issue than they used to be. In the aftermath of the Great Recession, "more and more kids are moving in with parents and grandparents," says Jim Gillespie, president and chief executive of Coldwell Banker Real Estate LLC.

Some adult children object to their parents' selling the home they grew up in because they are afraid it will cut their inheritance, says Prof. Kotlikoff. One way to address that problem: Give the children some of the sales proceeds right away.

Other strategies for living better in retirement might include paying off the mortgage, working longer or postponing taking Social Security, or increasing taxable contributions to a Roth individual retirement account, some financial planners say.

Charlie Horne, 71, a semiretired real-estate broker, and his wife, Barbara, 61, may have to use one of those strategies now that their downsizing move has turned out to be less advantageous than they had hoped. The couple recently sold their 3,000-square-foot, three-level house in Holliston, Mass., to move into a 2,200-square-foot condominium in a nearby development restricted to people 55 and older.

Their mistake: making a down payment on the new place before selling the old one. It took 11 months for the Hornes, who had owned their house for five years, to sell it, and it fetched just $540,000, far less than the $730,000 at which it was appraised the year before. The condo cost about the same with upgrades. "We thought it would be no problem [to sell]. I've been a Realtor for 52 years, and I've seen six recessions already," Mr. Horne says.

The couple's mortgage is about $380,000, or $3,900 a month. That, along with common charges of $310 per month, add up to just about as much as their old first and second mortgages and taxes. On the plus side, "the taxes were higher on the house than the condo," says Mr. Horne, who adds that he is saving money on maintenance.

Still, Mr. Horne says, if he had it to do over, he would sell the house first. "My timing was wrong," he says.