Why Clients Fail At Retirement

Second Homes
For many affluent clients, a separate vacation home represents the fulfillment of the American dream. If it is close enough to their primary residence, it’s a getaway place to go on weekends. If it’s further away like Florida, it’s a future retirement home and winter escape haven.

But in clients’ eyes, it’s almost always a good investment. They rarely consider the problems likely to arise.

Most popular places for second homes tend to be located in nice areas, often near water or mountains. From Florida to Maine, these properties are particularly vulnerable to hurricanes and other natural disasters. In California, one can add brush fires to the list. After inevitable disasters occur, the scramble for home insurance becomes an expensive obstacle course.

For a client still working and earning between $150,000 and $400,000, buying a second home after they have paid off the mortgage on their primary residence doesn’t seem like that serious a stretch. Once upon a time, accountants would recommend it; now tax deductions on second homes no long exist.

Still, buying that dream vacation home is a situation many advisors typically confront when clients reach their peak earning years prior to retirement, notes Karen Salvatore, principal with Shine Investment Advisory Services in Lone Tree, Colo. “They don’t understand the impact of maintaining two homes when they have smaller cash flows [in retirement],” she says.

Once a client retires and their income drops to the $70,000 to $120,000 area, upkeep and maintenance on two homes—even if a mortgage on the first home is paid off—can quickly assume an outsized position in their spending. “In many cases, an all-cash [purchase of a second home] could be ideal, but that takes a great deal of capital relative to their resources and may not be an option,” Salvatore says.

And when a downturn in the real estate market occurs, second homes in vacation areas typically become even more illiquid than other real estate markets. “Renting can become a necessity,” Salvatore notes.

According to Sullivan, the problems can become magnified for more affluent clients who earn annual incomes in the high six-figures—for several reasons. First, they are likely to buy more expensive second homes. Moreover, while they are working and making $900,000 a year, they are far less likely to scrutinize their spending, so when the paycheck stops the falloff in income can be much more dramatic.