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Homeowners with equity who are planning to sell face an important financial decision: What to do with their proceeds.
While many roll those dollars directly into their next real estate purchase, others opt to downsize to less expensive digs or rent temporarily while they test the waters in a new locale — leaving them with a pile of cash and plenty of options.
Depending on their financial picture and future goals, they can take all or part of their proceeds and:
“Sellers have a variety of options to put proceeds to work,” said Greg Hammond, a financial professional with Hammond Iles Wealth Advisors in Wethersfield, Connecticut. “Many find that downsizing can eliminate debt or a mortgage they may have now. Those who receive proceeds and do not need the money right now are investing for the future, creating a legacy for their family or charity, or are using the funds to address other concerns, such as long-term care. As many of our clients are aging, we are looking at life insurance policies with a long-term care rider that can provide peace of mind while creating a legacy.”
Housing market outlook
Home prices across the country hit record highs over the last few years, driven in part by tight inventory, work-from-home flexibility, and the exodus from major cities during the Covid-19 crisis. But as interest rates rose sharply in 2022, prices in some markets (specifically those in California) started to float back down to earth.
The National Association of Realtors projects home sales will decline by nearly 7 percent in 2023, compared with 2022, with the median home price reaching $385,800 — an increase of less than one percent from prior year.
"The demand for housing continues to outpace supply," said Lawrence Yun, chief economist for the National Association of Realtors, in a published forecast. "The economic conditions in place in the top 10 U.S. markets, all of which are located in the south, provide the support for home prices to climb by at least 5 percent in 2023."1
Those who own property in the most coveted suburbs, where housing prices have soared, are in some cases cashing in as they relocate to destinations where they can live for less and work from home.
Capital gains exclusions
Favorable tax laws may permit home sellers to keep more of their proceeds than they think.
The Internal Revenue Service allows married homeowners who file jointly to exclude up to $500,000 of proceeds from capital gains. ($250,000 for single homeowners.) If you purchased your home for $300,000 and sold it 12 years later for $500,000, the entire $200,000 gain would be tax free as long as you are eligible.
To qualify for the exclusion, you must have used the home as your primary residence, lived in it for at least two out of the last five years, and owned the property for at least two out of the last five years, among other criteria.
Those who sell in less than a year generally will owe short-term capital gains tax, which is equal to your ordinary income tax rate, while those who owned their property for more than a year but are not eligible for the capital gains exclusion will generally owe long-term capital gains, which cap out at 20 percent. (Learn more: Managing capital gains tax bites)
Regardless of how much you take home in proceeds, however, you must still decide how and when to put that money back to work.
Park it in savings
One option is to keep that money in savings, which is the safest choice for those who are determining next steps, said Chad Tourin, a financial professional with Coastal Wealth in Ft. Lauderdale, Florida.
“If you might need to tap into the sales proceeds within a few years, you would want those funds to be accessible without fees or penalties,” he said. “The treatment of proceeds from the sale of real estate should take into account many of the same factors as other windfalls. This includes liquidity needs. If you do not have adequate savings built up and you may need to access the funds, it would be important to keep the proceeds in a liquid account.”
Just be sure you segregate those savings into a “do not touch” account, lest you fritter away your proceeds on frivolous wants versus needs. Windfalls can be an excellent way to build wealth, but only if you use those dollars with intent.
Remember, too, that a large sum of money sitting in savings for too long presents a risk of its own. With an average interest rate of less than 1 percent, savings accounts won’t keep pace with inflation, which robs you of purchasing power over time.
For that reason, Tourin said he recommends using higher-yield cash equivalent accounts.
“After you’ve accumulated three months’ worth of emergency funds, at a minimum, you can put the proceeds to work for you in short-term vehicles, such as certificates of deposit or money market accounts, which provide a slightly higher interest with minimal risk and liquidity,” he said.
Pay down debt
Nothing creates financial drag like debt. Car loans, student loans, and credit card balances all limit our ability to meet other financial goals, like saving for a comfortable retirement, college savings for our children, or that beach house you can’t stop daydreaming about.
The average balance for American families with credit card debt reached $5,221 in 2022, according to Experian credit rating agency.. Nationally, more than 45 million borrowers carry student loan debt, with average federal student loan debt of $37,574 and average private student loan debt of $54,921 per borrower.2,3
When helping clients pare down debt, Tourin said he first looks at the type of debt involved, whether interest on that debt is potentially tax deductible (mortgages and student loans), and the interest rate. (Learn more: Good debt versus bad debt)
“This is a vital factor in the analysis of determining whether to pay down debt, because if you can earn a greater rate of return [by investing those proceeds] than the interest rate you are paying on that debt, it may make sense to put your money to work for you elsewhere,” he said.
Hammond agrees, but adds that the emotional return on being debt free can potentially outweigh the benefit of wealth accumulation.
“Investing to get a better financial result over time when it causes you to lose sleep or have anxiety about your debt does not make sense,” he said. “Carrying debt, even if it makes financial sense, that impedes your ability to live a life of freedom and fulfillment is not worth it.”
Invest for growth
If you prioritize wealth accumulation, do not require liquidity (immediate access to your cash), and are willing to assume greater risk, you might opt to invest those proceeds instead.
A hypothetical $75,000 investment in a taxable portfolio earning 7 percent annually would be worth an estimated $148,000 in 10 years, according to the investment calculator on Calculator.net. An investment of $150,000 would be worth $295,000 with the same parameters.
As an investor, your asset allocation determines your level of risk. If your portfolio is composed primarily of stocks (or equities), the potential return on investment may be higher, but it is also likely to be more volatile than a blended portfolio that incorporates fixed income (or bonds). It may also be subject to bigger losses.
By contrast, an investment portfolio composed entirely of high-quality fixed-income securities involves less risk, but also offers the least upside potential. For the most conservative investors who are looking for asset preservation and slightly higher returns than they might receive from a traditional savings account, putting their proceeds into a fixed-income fund might make sense. (Learn more: Understanding the basics of investing)
Longer time horizons may permit you to assume greater risk because you have years ahead to ride out market swings. But Tourin said any investment strategy must factor in your tolerance for risk.
“Everyone has different levels of risk tolerance,” he said. “Those with a higher tolerance are more likely to invest sales proceeds for growth and those with lower levels of risk tolerance should utilize more conservative strategies.”
A financial professional can help you create an asset allocation that is right for you.
Supplement your retirement
Many homeowners with appreciated property sell with the sole intent of liberating those proceeds to supplement their retirement savings, especially empty nesters and new retirees.
“Once someone is in retirement, or even as they are approaching retirement, their concerns typically shift from total assets and rate of return to a concern over how much income their assets are going to generate on a yearly basis,” said Tourin. “This is tied to arguably the biggest concern a retiree has, which is the fear of running out of money.”
Longevity risk can be alleviated, or at least mitigated, by using your proceeds to purchase a guaranteed income annuity, he said.
“These plans can even be designed to provide guaranteed income for life for both spouses and so, as long as there isn’t a liquidity need, an income annuity can be a great strategy to put your sale proceeds to work,” said Tourin. (Learn more: How do annuities work?)
Permanent life insurance can also play a valuable role in retirement planning, providing tax-free growth, cash value from which to draw when your investment portfolio returns are down, and estate planning benefits.4 (Learn more: How life insurance can help you in retirement)
MassMutual’s retirement calculator can help you determine whether you are on track for your retirement savings goal.
Real estate proceeds can also potentially be used to purchase long-term care insurance coverage, which may help protect your savings and preserve your estate for your heirs. Some life insurance companies offer whole life insurance policies with riders that provide long-term care benefits.
Putting your proceeds to good use
If you’re not planning to roll your real estate proceeds into the next property when you sell your home, you must decide where to put your proceeds.
Depending on your financial circumstances, it might make sense to pay down debt, invest for growth, or supplement your retirement. You might also consider purchasing products to protect yourself and your loved ones, including annuities, life insurance, or long-term care coverage.
By working closely with a trusted financial professional, you may be better positioned to create a plan that helps you reach your goals. (Learn more: 7 things financial planning does for you)
“Just like using a GPS system in your car, the first step is to determine the destination,” said Hammond. “From there, we can look at where you are and how you can create a clear path from where you are to where you want to go. As with a GPS, my role as a financial coach is not only to provide the path, but to point out the obstacles and challenges that you can see or may not see along the route. Based on the path and destination, we can then provide guidance as to the best way to invest the funds, whether it is conservative or growth oriented.”
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This article was originally published in March 2020. It has been updated.
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1 National Association of Realtors, “NAR forecasts 4.78 Million Existing-Home Sales, Stable Prices in 2023,” Dec. 13, 2022..
2 Experian, “Credit Scores Steady as Consumer Debt Balances Rise in 2022,” Feb. 24, 2023.
3 Education Data Initiative, “Average Student Loan Debt,” Jan. 22, 2023.
4 Borrowing against cash value increases the chances that the policy will lapse, reduces the cash value and death benefit, and may result in a tax bill if the policy terminates before the death of the insured.