For retirees, downsizing has many upsides

If you are getting on in age and still own the home you bought when your kids were young, you've probably given some thought to downsizing. Many homeowners figure they'll downsize someday, but few eventually take the plunge.

Alan Biederman did a year ago, when he sold his four-bedroom home in Hazlet, New Jersey. Biederman, a 61-year-old magazine production manager, intends to retire in June and relocate to Rodgers, Minnesota, where he and his wife recently bought a newly built two-bedroom town home for much less than the sale price of their former home.

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Biederman said a health scare five years ago led him to give some serious thought as to how he wanted to spend the rest of his life. Tired of his punishing commute into Manhattan for work, he began taking steps to ease into retirement, which included putting his longtime home on the market.

"The house just got too big for us," said Biederman, explaining that he and his wife no longer needed as much space as they did when their kids were young, nor did they want the hassles of maintaining a big home. They decided to move to Minnesota to be near one of their grown daughters.

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Had it not been for his health crisis, Biederman might not have made such big changes.

A small percentage of older Americans downsize. Of those who do, some do it by choice and others do it out of necessity tied to financial hardship, health issues or other problems, said Rodney Harrell, a housing expert at AARP. Most Americans age 50 and older actually want to "age in place," noted Harrell.

Not surprisingly, Harrell said it is better to take a proactive approach to housing as you age. Moving is hard at any age, and it only becomes more difficult as we grow older.

People who are able to think ahead about what they might need if their health fails, their spouse dies or some other major event occurs put themselves in a much better position to actually get what they need, Harrell explained.

"A lot of people make the mistake of not focusing on location.The design of the home is important, but where it is located makes a big difference." -Rodney Harrell, housing expert at AARP

There are many considerations when it comes to downsizing, which generally entails moving to a less expensive—not just smaller—home. If you can earn a tidy profit on your home after selling and moving costs, downsizing is one way to boost your income during retirement. It will add to savings and ideally generate a higher level of investment income on your larger nest egg.

By cutting housing-related expenses, you can also free up income and thus draw down your savings at a slower rate. Taxes, insurance, upkeep and utility bills typically run about 3.25 percent of the value of a house, according to a report by the Center for Retirement Research at Boston College. Theoretically, you'll spend less on those items if you trade down to a house that costs less.

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But financial issues are only part of the equation.

Harrell said it behooves older Americans to think about whether their existing homes will meet their needs later in life—for example, if stairs become an issue. The location of a home is also an important consideration, he said, noting that some retirees prefer to live in places where they can easily walk to shops and other amenities or where they are well served by public transportation. Opportunities for social interaction are another factor to consider.

"A lot of people make the mistake of not focusing on location," Harrell said. "The design of the home is important, but where it is located makes a big difference."

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Like Biederman, some older adults decide to make a long-distance move in order to live closer to family members or settle in a place with a lower cost of living.

Demographer Joel Kotkin, executive director of the Houston-based Center for Opportunity Urbanism, said that contrary to media reports, American seniors aren't flocking to big cities.

"Seniors usually prefer to stay where they are," he said. "If they are going to move, they will move to a small town and maybe find a place within walking distance of things. "They generally aren't moving to an expensive, bustling urban center," Kotkin added. "That's not downsizing."

Those who do uproot themselves tend to gravitate toward small towns in scenic areas of the country with a relatively low cost of living, Kotkin said, such as Bend, Oregon, or Grass Valley, California.

Renting vs. buying

With a long-distance move, it may make more sense to rent initially rather than to buy, said Erik Carter, a certified financial planner and senior resident planner at Financial Finesse. Renting for a year gives you time to check out different neighborhoods and decide whether a new city or town is a good fit.

Many people believe that once they sell a home, they must buy a new one right away to avoid owing capital gains taxes on the profit from their sale, Carter said. However, as long as you lived in your home for two of the last five years, $250,000 in profit from the sale of that property is exempt from capital gains taxes for single sellers, and $500,000 is exempt if you are married, he explained.

States with no income taxes, such as Nevada and Florida, have long been a draw for retirees. But Carter said it's important to consider the bigger picture from a tax perspective, because states with no income tax may have relatively high property taxes.

"I tend to find people's tax bracket is lower in retirement than they think it will be," he said. "So income tax may not be as big of a factor as property tax."

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For many people, housing is their single biggest expense. But if you are nearing retirement, it's a good idea to take a look at all of your expenses and, of course, your assets to determine whether you need to adjust your spending habits or perhaps your expectations for retirement, said Douglas Kobak, a CFP and principal at Main Line Group Wealth Management.

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Many people, he said, underestimate how much they'll need for retirement, because they don't consider the fact that spending on leisure activities, particularly travel, tends to pick up significantly during the first five to eight years of retirement, when many of us are still healthy enough to take those trips we've been putting off.

"Three to five years out, you want to look at your assets and expenses to determine whether it is realistic to retire in the style in which you expect to retire or whether you need to modify your expectations for retirement," Kobak said.

—By Anna Robaton, special to CNBC.com