Canadians have great expectations when it comes to using their homes to feather their retirement nest eggs.
A recent survey by Nanos Research Group for Bloomberg News shows six out of every 10 respondents said they expect real estate values will climb in their neighbourhood over the next six months. That’s the highest level on record for the survey since its inception in 2008.
The results are adding to speculation that red-hot Canadian housing markets are in a bubble, but it’s not hard to see why many are counting on their principal residence to make up a bigger chunk of their retirement savings.
And why not? While house prices might not always increase during six-month intervals, Canada Mortgage and Housing Corporation (CMHC) says the average annual increase in property values over 20 and 30-year periods has always exceeded five per cent since the end of the Second World War. That’s in line with much more volatile equity markets for the growing number of Canadians who invest in equities for retirement through defined contribution pension plans and Registered Retirement Savings Plans (RRSP).
Home equity can help provide tax-free retirement income through a home equity line of credit (HELOC), a reverse mortgage, or downsizing to a smaller home.
How much of a role a home should play in a retirement plan depends on the individual property and the needs of the individual retiree, but if you want to measure it against some of the other holdings in a retirement portfolio there are a few things to consider.
While risk in a portfolio of stocks can be diversified across sectors and geographic lines, your home is restricted to one sector (real estate), one sub-sector (residential) and one geographic area (your neighbourhood). Data on home values are based on averages and not all homes appreciate at the same rate; or appreciate at all.
One of the biggest advantages to home ownership versus the stock market is its ability to hold its intrinsic, or real, value. A stock won’t keep you dry in a thunderstorm. Everyone needs a place to live.
One of the biggest investment advantages to owning a home is a tax exemption on any gain from the sale of a principal residence. Half of any gain on an equity investment is taxed, and if it is in an RRSP it is fully taxed when it is withdrawn.
The tax treatment on the sale of a principal residence is more like a Tax Free Savings Account (TFSA), where gains are never taxed. A good tax saving strategy involves withdrawing fully taxable income from an RRSP, company pension, Canada Pension Plan (CPP) or Old Age Security (OAS) at a low marginal rate and topping it up with tax-free money from a TFSA or home equity.
The capital gains tax exemption on principal residences has come into question recently. RBC Economics waded into the debate this week on how best to cool the hottest housing markets by suggesting policymakers should consider imposing a capital gains tax on the sale of a principal residence, much like a secondary residence or any other equity investment. The RBC report refers to the current exemption from that tax as a “sacred cow”.
It’s a frightening prospect, and political suicide for any government with the nerve. It’s also unlikely that it would apply to current home owners. If the objective is really to cool hot housing markets, any measure would be aimed at speculators with huge capital gains and not Canadians trying to live a decent retirement.