Financial advisors can help their clients retire early and improve their retirement security by educating them about “house hacking.” Popular in the FIRE community (Financial Independence Retire Early), house hacking has become widely understood by young people today. But I think there is an even bigger opportunity — for baby boomers — to embrace house hacking and significantly improve their retirement readiness.
What is house hacking? It means buying a multi-family property, typically a duplex or triplex, and living in one unit while renting the other units. With the rent coming in, the owner can reduce their monthly expenses to a minimum, or even live for free. For example, I own a very modest duplex. And while it is not my primary residence, it would work as a house hack. My mortgage is $810 a month. The upstairs unit is rented for $850. If I wanted, I could live downstairs “for free.” (Instead, we rent the downstairs unit on Airbnb here.)
Today, most Baby Boomers are marginally prepared for retirement. You might not see it in your practice, but not every 60-year-old is debt-free with a $2 million 401(k) account. According to Fidelity Investments, the average 401(k) balance for participants age 60 to 69 is just $182,100.
For the majority of Americans, housing is likely to be either their biggest expense in retirement or their biggest asset. By age 60, most of our years of earning wages, accumulating assets and experiencing investment growth are behind us. So if those retirement accounts are less than ideal, focusing on saving goals and investment accounts, which may not have sufficient years to compound, may not be enough. There is an opportunity for financial advisors to help clients with both sides of the retirement equation by evaluating income and expenses.
How House Hacking Works
To understand the benefits of house hacking for retirement, let’s consider two hypothetical clients. You probably have clients in similar situations.
Debbie is 62 and worries that she will never be able to retire. She works full time and has a decent income, but only has $350,000 in her retirement accounts. She has three kids from her former marriage, who are grown up now. Over the years, she raised her kids, paid for their college educations and weddings, and now wants to spoil her two grandchildren. Debbie is renting a home for $1,800 a month. You run her numbers through your financial planning software, including Social Security, and determine that she is not on track to fund her current lifestyle in retirement.
Debbie is a great candidate for house hacking. Since she is working, she can easily qualify for a mortgage. And as a first-time homebuyer, she can obtain an FHA mortgage with as little at 3.5% down. She buys a duplex with a monthly mortgage of $1,900 and rents out one unit for $1,600. She has reduced her monthly net housing spending from $1,800 to $300, saving $1,500 a month.
- By reducing her monthly budget by $1,500, Debbie now needs $450,000 less in her target retirement account. How do we get that figure? Using the 4% rule, $450,000 is the amount required for $1,500 a month in spending.
- While Debbie is still working, she can now afford to bump up her 401(k) or IRA contributions by $1,500 a month, or $18,000 a year. She can save more.
- Rents will go up whereas Debbie’s mortgage is fixed. She should be able to increase the rent she charges and possibly reduce her expense from $300 per month to $0 over time.
- Debbie will also be building equity in her home as she pays down the mortgage and as the home value appreciates.
Harold and Rebecca: House Rich but Cash Poor
Harold and Rebecca are both 60 years old. Their children and grandchildren all live out of state. It pains them how much their grandchildren grow and change when they don’t get to see them for three- to four-month stretches. They are grateful for their $750,000 in IRAs, but know that is not enough to retire today. You have calculated that for Rebecca and Harold to be comfortable, they will have to keep working until at least age 65. They also have a $1 million home — a five-bedroom house where they raised their kids. They paid off their mortgage a few years ago and are surprised by their home’s value today.
Harold and Rebecca are house rich and cash poor, which they can address by house hacking. They sell their house for $1 million. As their primary residence, they get a $500,000 capital gains exclusion and receive the proceeds tax-free. To house hack, they put $200,000 down on a $1 million luxury triplex. Their monthly mortgage with insurance and taxes is $5,500 a month. They rent two of the units, each for $2,800 a month.
- By selling their house, Harold and Rebecca unlock $800,000 of equity that they now invest for retirement funding. At a 4% withdrawal rate, you suggest they can safely take $2,666 a month from this account. They can leave their IRAs to grow for another five years, retire now and spend half the year visiting their grandkids.
- Many people place unjustified value on being debt-free. Yes, we should avoid bad debt. But by taking a mortgage on the triplex, Harold and Rebecca can access their home equity and successfully fund their early retirement. The rent from two units of $5,600 fully covers their $5,500 monthly mortgage expense.
- They had paid off their house but were still responsible for taxes and insurance. In the triplex, the tenants’ rent also covers the annual taxes and insurance.
- By downsizing their living space, they can save on expenses such as utilities. How many of your empty-nester clients are still living in a four- or five-bedroom house? At what cost?
Yes, There Are Headaches
Clearly, house hacking is not for everyone. The “cons” to this strategy are fairly obvious. Many of your clients who live in a single-family house may balk at the idea of sharing a building with other residents and potentially hearing sounds from other people. It may even feel like a step backward coming from a large house. While they may reduce their monthly living expenses, they are still responsible for repairs, maintenance and lawncare. There may be some headaches involved with managing tenants and they should budget for some turnover and vacancy.
Still, for some of your clients, this creative approach to paying for housing could help them retire with more security or retire years earlier. Unfortunately, many financial advisors are reluctant to give budget advice. They fear that talking about expenses always comes down to telling a client that they “spend too much.” Asking clients to figure out how to tighten their belts is a losing proposition that damages the advisory relationship.
To add value, we need to offer solutions and options, not just identify a problem. And that’s why house hacking can work as an advisor recommendation. By reducing monthly expenses from $5,000 to $4,000, a couple might in fact be ready for retirement today and won’t need to work for an additional five years.
Given a choice of retiring now with a house hack or working five years longer, some of your clients are going to choose the house hack. Some are going to love the idea. You’re going to be the advisor who helped them retire five years earlier. Investments are important, but your selection of a mutual fund or ETF is probably not going to have as big an impact on your client’s situation as house hacking could. Especially if they are under-saved for retirement.
Some clients are more adventurous than you give them credit. They’re ready for a change. Many just need to take a look at the numbers and consider what house hacking might mean for their freedom and security to be willing to make it happen.
Do you have clients who might benefit from house hacking? Forward them this article and just ask if they’ve ever heard of house hacking. It might be a conversation worth starting.
Scott Stratton, CFPⓇ, CFA is the president of Good Life Wealth Management, a registered investment advisor in Little Rock, Ark. He can be reached at [email protected].