Conventional wisdom has it that investing in a home is a good and responsible way to save for retirement. But new evidence suggests property may not be the answer to boosting pension income.

The idea is that as the home increases in value and the mortgage is paid off, it becomes an increasingly valuable asset that can eventually be used to supplement pension income. The strategy has held increasing appeal as house prices have soared in many parts of the country (see table, page 4) and more and more people realize their defined-contribution pension plans or personal RRSPs may fail to generate enough money to provide them with a decent income by the time they want to retire.

But preliminary results of a new survey of work and savings from Mercer Human Resources Consulting in Britain may have lessons that Canadian advisors will want to bring to the attention of their clients — particularly those who are planning to use their homes as their fallback position when it comes to retirement income.

The survey found that as many as one in three people in Britain with DC pension plans are relying on the houses they live in to form an important part of their retirement incomes. But, Mercer says, while a minority of people will be able to downsize their properties and use the extra capital to buy a substantial annuity, selling a home to fund retirement will not be a viable solution for most.

That’s because the cost of renting a home in most British housing markets will eat up all the income produced by selling the person’s existing house and buying an annuity, Mercer says. The analysis shows the cost of the average house in Britain — about £173,000, or roughly $376,000 — could be used to buy an annuity worth about £6,700 a year after taxes. But with average rental costs at £6,800 a year, the annuity would not provide enough to pay the rent. Even in the West Midlands, where average rental costs are lowest relative to house prices, annual retirement income after taxes and rent would be only £1,900 (about $4,100), the survey found.

The same analysis shows anyone choosing to downsize from an average semi-detached home to an average terraced house would be able to buy an annuity of just £1,100 — roughly $2,400 — a year after taxes.

Dr. Deborah Cooper, a principal at Mercer in Britain, notes: “People with expensive houses who will be able to downsize are unlikely to be those who are relying on their homes as their main source of retirement income. For most defined-contribution pension plan members, selling a home to buy an annuity will provide little income, if any at all, once rental or repurchasing costs have been taken into account.”

On a cautionary note, she adds, “If people fail to save enough now and rely on selling their homes to provide an income, they could be in for a nasty shock at retirement.”

According to the survey, 55% of respondents thought a company pension plan is the best way to save for retirement. But only 44% thought their employer was doing enough to help them prepare financially for retirement.

At least, with company pension plans, members benefit from employer contributions, Cooper notes. And companies are generally well placed to help employees understand how much they need to save for retirement and how to maximize their savings, she adds.

But, she observes, “A lot of people tend to doze off when the subject turns to pensions. They could have a rude awakening when they reach retirement.”

Booming house prices in Canada and the U.S. could well encourage homeowners here to assume their homes will continue to increase in value indefinitely. But, just like the stock market, housing prices can also be subject to booms and busts. That could be a problem for anyone whose home falls in value just when they are hoping to cash in.

One study from the Bank for International Settlements in Switzerland looked at housing price bubbles in 14 countries and concluded large housing price increases over several years are not necessarily good indicators of forthcoming busts.

“While housing price busts are infrequent events, they nevertheless occur frequently enough to be of great concern to policy-makers and investors alike,” warns the BIS study’s author, Thomas F. Helbling.

@page_break@Paul Ferley, assistant chief economist at Bank of Montreal in Toronto, points out Canada experienced a housing bubble in the late 1980s, when speculators entered housing markets and pushed prices up. But, Ferley says, “The current environment doesn’t come close to that.”

He believes the recent rise in house prices reflects low interest rates rather than speculative activity. It’s an indication of strong underlying economic fundamentals, he says, although rapid price increases in some markets, such as Edmonton, could move the housing market into “bubble” territory.

Real estate economist and forecaster Peter Norman, a vice president with Toronto-based Clayton Research Associates Ltd. , points out that Canadians who are homeowners are also more likely to have higher financial assets and, therefore, less likely to need to tap into the value of a home to supplement pension income. He suggests those who don’t have enough retirement income tend to be people who don’t own homes anyway.

“I don’t see the idea of people liquidating their homes at retirement,” says Norman.

For those who need extra cash, he points out, there are other ways to tap into the value of the home. Downsizing to a smaller property, home-equity lines of credit or reverse mortgages are all possibilities, he adds. Only 25% of Canadian homeowners actually engage in downsizing between ages 65 sand 75, he says. In fact, he points out, the number of homeowners who start renovations goes up significantly after retirement.

Like Norman, Bob Dugan, chief economist at Canada Mortgage and Housing Corp. in Ottawa, believes the scenario in which people sell their houses at retirement doesn’t seem too probable. Now that condos are becoming a popular form of home ownership, says Dugan, seniors who don’t want the hassle of home ownership may move to condos rather than rentals.

“That’s also a legitimate strategy for cashing in on some of the savings that are tied up in a home,” he adds.

But Dugan highlights the risk of having all your eggs in one basket if the market is poor when you have to sell. House prices are largely determined by demand, he says, and it’s demographics that influence demand. There are cycles in the housing market, just as there are cycles in the stock market, he observes.

CMHC is currently working on long-term projections of housing demand — both ownership and rental — 20 years down the road, based on the 2001 population census. There’s no indication yet of when the projections might be available.

Meanwhile, Dugan says, if clients are looking at housing as an asset in a potential retirement income portfolio, the usual rules apply: diversify the portfolio.

“It’s very dangerous to put so much of your portfolio in one asset,” he says, “counting on it to do very well and maybe being disappointed when you have to sell and, perhaps, not get the kind of retirement income you had hoped for.” IE