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Retirement
Older couple sit on the couch, looking upset and away from each other. YuriArcursPeopleimages/Envato

Downsizing after retirement often makes no sense — are you locking yourself in for a smaller life than you should?

Empty-nesters now own almost one-third of the country’s large homes — the same share they held over a decade before. And while there are plenty of young families looking for a home, baby boomers aren’t ready to give up their homes just yet.

While downsizing might seem like it’d be a financial no-brainer — a chance to unlock all the equity they’ve spent years building and slash your annual property taxes and maintenance costs by moving into a smaller house or condo — Redfin data shows boomers are thinking twice about making a big move.

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So what’s keeping so many older Americans and retirees from making the big move? In short: money.

Retire on your terms — we'll show you how.

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Here’s what you need to know to make the right choice for you when the time comes.

The hidden costs of downsizing

On the surface, downsizing seems like a simple math problem. Take the fair market value of a large four-bedroom detached house and subtract the market value of a smaller, two-bedroom apartment and the difference is your ticket to financial freedom.

However, this simple calculation overlooks many of the hidden costs of buying and selling homes. Agent commissions, closing costs, taxes, home repairs, mortgage repayment and other additional costs can all add up to 10% to 15% of your home’s final selling price, according to Experian.

It can also cost as much as $10,000 if you’re moving long-distance, such as from the East Coast to the West Coast, according to Rocket Mortgage.

Beyond these transaction costs, there’s also capital gains taxes to consider. The Internal Revenue Service (IRS) exempts up to $500,000 in capital gains for a married couple filing taxes together. But if you’ve owned your home for a few decades in a relatively high-cost-of-living region, there’s a chance your gains exceed this threshold.

For many millionaire homeowners, this tax is an additional barrier to downsizing.

For others, the mortgage rate is a key concern. As Redfin notes, the majority of baby boomers (58%) have already paid off their mortgages. Even if they haven’t, many benefit from ultra-low mortgage rates — and that’s not something they’re keen to give up with rates now at 6.65%.

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And finally, selling your home can have implications on your Medicare costs thanks to IRMAA (income-related monthly adjusted amount).

Simply put, there are many common scenarios where downsizing doesn’t make financial sense. The costs and taxes can diminish the appeal of moving to a smaller home, let alone the lifestyle challenge of adapting to a smaller space.

Redfin adds there’s also a non-monetary rationale behind staying put.

“There are also social and lifestyle reasons to stay put: Baby boomers, in their sixties and seventies, may want to stay in the neighborhoods they’ve lived in for a long time, close to their friends, family, work and/or recreational activities.”

That being said, downsizing isn’t always a bad idea.

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When downsizing makes sense

There are specific circumstances where downsizing is clearly the right financial and lifestyle decision.

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The calculus starts to favor a move when the gap in shelter costs is genuinely substantial — for example, moving from a high property-tax suburb to a lower-tax area with lower carrying costs, where the annual savings run into the tens of thousands. In those cases, the transaction costs can be paid back relatively quickly.

The tax impact also becomes a net positive when your gain falls under the exclusion threshold and you move from an expensive market to a dramatically cheaper one, allowing you to invest a meaningful lump sum that could generate additional retirement income.

Finally, proximity to family is perhaps the most legitimate non-financial factor. If your children and grandchildren are far away and your health is trending in a direction that makes independence uncertain, no spreadsheet should keep you rooted to a specific location.

Bottom line: downsizing isn’t always a slam dunk, but a closer look at your personal situation could help you make the right decision.

with files from Sigrid Forberg

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Vishesh Raisinghani Freelance Writer

Vishesh Raisinghani is a financial journalist covering personal finance, investing and the global economy. He's also the founder of Sharpe Ascension Inc., a content marketing agency focused on investment firms. His work has appeared in Moneywise, Yahoo Finance!, Motley Fool, Seeking Alpha, Mergers & Acquisitions Magazine and Piggybank.

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