3 Reasons Why Home Equity Doesn't Work as Retirement Savings

Homeowners often wonder if their home equity counts as retirement savings. After all, if you own a home, it's likely one of your largest assets.

You can certainly take your home into account when planning for retirement. Once it's paid off, you won't have a housing payment, so you won't need as much money in your investment accounts as retirees who rent. But it's not a good idea to use home equity as a substitute for retirement savings, for a few reasons.

1. You'll miss out on tax breaks if you don't contribute to retirement accounts

The federal government wants Americans to save for retirement. To encourage that, it offers tax incentives for contributing to retirement accounts, including 401(k) plans at work and individual retirement accounts (IRAs).

With a Traditional 401(k) or IRA, you can deduct contributions from your taxable income. Another option is a Roth 401(k) or Roth IRA. Contributions to those aren't tax-deductible, but you can make tax-free withdrawals in retirement. Here are the contribution limits for these types of retirement accounts in 2024:

• 401(k): $23,000 (plus $7,500 in catch-up contributions if you're 50 or older)
• IRA: $7,000 (plus $1,000 in catch-up contributions if you're 50 or older)

Let's say your household earns $100,000 per year. If you contributed $10,000 per year to a Traditional 401(k), you could save $2,200 in income taxes.

2. You can't easily tap into your home equity

When you're retired, you'll need money you can easily access to pay your bills. Retirement savings is perfect for this. Even if you have it invested, which is a good idea, you can sell investments as needed and withdraw the money.

While there are ways to tap into home equity, they're not ideal for retirees. You could get a home equity line of credit (HELOC), but you'd need to pay that back. There are also reverse mortgages, but these are complicated and have more fees than regular mortgages do. The final option is to sell your home, downsize, and use the profits as retirement savings.

It's certainly possible to get money from your home equity, but in each case, it's a hassle. You're better off looking at your home as a place to live rather than a way to fund your retirement.

3. It doesn't generate any income for you

When you invest your retirement savings, it can make money for you. One of the ways this happens is through the growth of your investments. If your retirement savings goes from $500,000 to $525,000, that's an additional $25,000 you can use.

To be fair, your home can grow in value, too. But as mentioned above, there aren't any easy ways to tap into your home equity, so you can't withdraw from that additional value whenever you want.

There are also investments that generate income on a fixed schedule. You can't get a fixed paycheck from your home unless you rent out a portion of it. Examples of investments you can use for passive income include:

• Stocks that pay dividends (a portion of profits returned to shareholders)
• Certificates of deposit (CDs)
• Treasury bills, notes, and bonds

How to factor your home into your retirement planning

Owning a home isn't a substitute for retirement savings, but it does affect how much you need to save. For most Americans, their largest monthly expense is housing. If you won't have a housing payment in retirement, you can adjust your savings goals accordingly.

A common rule of thumb for retirement planning is the 4% rule. The idea behind it is that retirees can safely withdraw up to 4% of their retirement savings per year. So to figure out how much you need for retirement, you can multiply the annual income you want in retirement by 25.

Let's say you spend $80,000 per year. Multiplied by 25, you'd need $2 million. However, you also currently have a $2,000 monthly housing payment. That's $24,000 per year that you won't be spending in retirement. If you subtract that, you'd only need $56,000 per year, for a retirement savings goal of $1.4 million.

That's just a quick example -- you'll definitely want to thoroughly run your own numbers. It makes sense to do this so you can account for owning a home in your retirement planning. Just also remember that everyone needs retirement savings, and home equity alone isn't a good way to fund your retirement.