How to Use Real Estate to Supplement Your Retirement Income (Part I)
May 07, 2014One of the most popular workshops we offer at Financial Finesse is our workshops on retirement planning. That’s probably because retirement is a financial goal common to just about anyone that works for a living. In order to enjoy a comfortable retirement, many financial experts recommend replacing 70-80% of your income in retirement, which begs the question “What are your retirement income sources?”
For most employees, Social Security will be a source of income in retirement as long as you have paid into the system for at least 40 quarters. Others may be eligible for a pension benefit. But for the vast majority of Americans, the primary source of retirement income will come from what they save in their employer’s retirement plan (e.g., profit sharing, 401(k)) and Individual Retirement Account (IRA).
Combined, these sources may replace 40%, 50%, maybe as much as 60% or more of your pre-retirement income but what if that’s not enough? More and more Americans are turning to real estate as a major source of retirement income. In this and next week’s blog posts, I’ll review different ways you can use this important asset to enjoy your golden years.
Rental property
According to the National Multifamily Housing Council, 35% of households in the U.S. are renting, and demand for rental units is projected to rise. For future retirees, that means opportunities for future potential income streams. For my colleague, Bruce, when he and his wife recently relocated, they decided to keep their prior residence and rent it out while finding a new home where they live now.
Others, like my colleague, Linda, actively looked for rental properties in areas where she and her husband would like to retire. When a unit became available, she quickly snatched it up. In fact, she bought two units next to each other, so now when she retires, she can live in one unit while she rents out the other.
If you’re interested in learning more about buying investment property, check out Erik Carter’s blog post on “What to Look For In an Investment Property”. If you’re not interested in buying investment property, perhaps you can rent out a spare room or a room over the garage. Either way, you will want to make sure you charge enough, but not too much, in rent. Visit www.rentometer.com for a quick check of average high and low rental rates for properties like yours. Finally, owning rental property and renting out a room offers tax benefits that help offset tax liability, making income from rents one of the more tax-efficient ways to create retirement income.
On the other hand, being a landlord means finding renters, doing upkeep, and filing a slightly more complicated tax return. (Depending on the type of property, you may be able to hire a property management company to help you with some of these issues.) If you own physical real estate, you are also subject to fluctuations in local property values (geographic risk), and you could have problems selling the property if you needed to offload it in a hurry (liquidity risk).
Real Estate Investment Trust (REIT)
Not ready to take the plunge into being a landlord? That’s okay. You can still own real estate by purchasing a REIT. REITs protect you from geographic and liquidity risk, but not necessarily market risk. REITs generally produce an income stream but the amount of income generated from a REIT is typically not as much as actually collecting rent on a physical property. REITs often pay dividends that are subject to ordinary income tax (unless the dividend is qualified) so unless you own a REIT in a tax-sheltered account like an IRA or a 401(k), you may not see the same tax advantages as enjoyed by physical property owners.
When you’re retired, you may need all the income you can get. Owning rental property and investing in REITs are just a couple of ways investors can use real estate to supplement their income in retirement. Next week, I’ll take a look at how you can use the equity in your home to supplement your retirement income as well.