(MONEY Magazine) – Tom and Mary Stott are getting ready to sell their 10-room Cape Cod-style home of 10 years and move into a six-room condominium. Their trade-down is not a reluctant retreat but part of a well-thought-out plan for a comfortable retirement. The Stotts, who both turn 65 this year, are asking $385,000 for their house in the Cape Cod community of Cummaquid. Of the proceeds, they will spend $190,000 on the condo, which overlooks a golf course in nearby Yarmouth Port. Another $35,000 will go for improvements to the condo, leaving them about $160,000 to invest in tax-exempt bonds. The housing swap, in fact, is what makes the difference between a tight retirement budget and the more easeful one the Stotts have mapped out. Tom, who called it quits four years ago as president of a Swedish shipbuilding firm's American subsidiary, estimates that lower property taxes, insurance premiums and maintenance costs on the condo will help reduce the couple's annual expenses to about $40,000; they would be $47,000 or so if the Stotts kept the house. His $300,000 Keogh account, which is invested in certificates of deposit, will supply income of about $18,000 a year, while Social Security payments will come to $14,000. The bonds will add about $12,800. ''Our five kids will inherit the condo when we're gone,'' says Tom. ''Meanwhile, we can entertain them in pleasant surroundings -- just as we did in our old house.'' Jimmy and Jacki Whitney also used their seven-room traditional brick house in Dallas as a centerpiece of their retirement plan. The couple sold the house last year for $148,000. They used part of the proceeds to pay off their $76,000 mortgage, put down $5,000 on a new Lincoln Town Car and moved to Oklahoma City. The couple chose Oklahoma City because they had lived there until 1971, and so that Jacki, 57, could be near her 83-year-old mother. Unwilling to buy a home that might prove difficult to sell if they move later, the couple instead rent a seven-room ranch-style house for $650 a month. Jimmy, 59, a retired sales executive, plans to invest the $67,000 remaining from the sale of the house in a balanced portfolio of mutual funds that he estimates will earn 8% to 10%. He figures that the fund payouts, plus his $23,000 pension and income from other investments, will be more than enough to meet expenses. ''Paying off the old mortgage freed up $1,165 a month,'' says Jimmy. ''On that money we can go to Europe twice a year.'' Like the Stotts and the Whitneys, more and more people are turning to the family residence, its value fattened by inflation, for retirement income. About 75% of Americans over 65 own their own homes, with an average of more than $50,000 in equity waiting to be tapped. Most retirees living on fixed incomes, however, don't earn enough to qualify for conventional home-equity loans, the simplest way to exploit this burgeoning asset. But selling out and buying or renting a smaller place is usually the smartest move anyway. On balance, it also outperforms such alternatives as taking a reverse mortgage, which is a loan against home equity that allows the borrower to defer repayment, or just staying put (see the table at right). What's best for you depends greatly on whether you need to raise money from your home -- and how much. Your retirement costs probably will come to about 70% of your pre-retirement expenses. If your expected income from investments, Social Security, pensions and other sources falls well short of your requirements, you may have little option but to tap your prime asset. Even if you can afford to stay in your home, you will have to pay a price. ''People wrongly think that if their home is paid for, it doesn't cost them anything to stay in it,'' says Robert Frater, a certified financial planner with Houston Asset Management Inc. ''They don't realize that trading down is the best way to raise your income, lower your living costs and preserve the value of your estate.''

TRADE-DOWNS Executing a trade-down calls for careful planning. Financial planners and housing specialists advise you to: -- Estimate your profit in advance. Before you sell your old house, try to find out what you will need to spend for a suitable replacement. If your potential profit is small, trading down might not be worth the trouble and expense. But be sure to take into account any savings you will realize from reduced maintenance and property taxes on a smaller home. ''Lower costs might make it worthwhile to move even if your profit from the trade-down is only $50,000,'' says Laura Adams, a certified financial planner in Princeton, N.J. -- Time your sale to take advantage of tax benefits. If you or your spouse is 55 or older, you may be able to exclude from taxes up to $125,000 of the capital gain on the sale of your home. Should your gain exceed $125,000, you can defer tax on the excess by reinvesting the money in a new residence. If you have lived in your home for less than three of the five years preceding the sale, however, you do not qualify for the exclusion. In that case, it's probably worth delaying the sale until you can take the tax break. -- Consider lending the buyer part of the purchase price. Interest payments on the loan will provide more income than you would receive if you sold for cash and invested the proceeds conservatively, such as in five-year Treasury notes, recently paying 8.3%. Reason: mortgage rates are currently almost two percentage points higher. Insist on a down payment of at least 20%. That will protect your principal if the buyer defaults on the loan and, in fact, is an incentive for him not to default. -- Pay cash for your new home. You could take out a mortgage and invest your money elsewhere, but the returns on conservative investments would not cover the loan payments. Just be sure that you leave yourself enough cash to meet emergencies and that you have other investments to offset the risk that your house might lose value. ''When you tie up all of your cash in a house, you lose the protection of a diversified portfolio,'' points out Harold Evensky, president of Evensky & Brown, a financial planning firm in Miami. -- Avoid variable-rate mortgages. If you must borrow to pay for your new home, get a mortgage with a fixed rate so that you will never have to worry about payments rising sharply. One alternative to trading down is selling and renting permanently. In the long run, selling your house and becoming a tenant might be less financially rewarding than trading down. But it might well provide enough cash to defray your housing costs and free considerable cash. And if you decide to move again, you won't be pinned down by the task of selling a home, which could prove difficult if the real estate market in your area goes soft. Of course, you may be among the homeowners who, like impoverished nobility in an English novel, wouldn't think of abandoning their castle even if they have to sell all the silver to pay the upkeep. In that case, you may want to consider one of the following techniques to hold on to the old place. Some of them are limited to certain regions, and others require the cooperation of relatives or outside investors.

REVERSE MORTGAGES Dora Lissemore, 89, of Tenafly, N.J. has lived since 1944 in a two-story house set among hundreds of rosebushes, many of them planted by her late husband Jack. When he died in 1981, his widow's income consisted of Social Security, a small annuity, a teacher's union insurance policy and royalties from a rose that the couple hybridized 17 years ago. The money wasn't enough to meet her expenses. ''I had begun to wonder how I could carry the house by myself,'' she says. ''But I didn't want to leave my garden and my friends and start all over.'' In 1982, Lissemore responded to an advertisement by American Homestead, a Mount Laurel, N.J. mortgage bank, and took out a reverse mortgage that pays her $700 a month. The extra money helps cover her property taxes, utility costs and medical bills, and dues to half a dozen clubs and other organizations, such as the American Rose Society. It also covers her subscription to Baseball Digest, in which she follows the fortunes of the New York Mets. Reverse mortgages -- complete with typical closing costs of 2.5% of the total loan -- pay the borrower a fixed monthly amount and defer repayment. They come in several forms, the most attractive being the Individual Reverse Mortgage Account (IRMA) that Lissemore opened, whereby the lender receives part or all of the value of your home, including its appreciation during the term of the loan, in return for deferring repayment until you either move or die. (In the latter case, your estate pays off the loan.) American Homestead offers IRMAs in Connecticut, Delaware, Maryland, Massachusetts, New Jersey, Ohio, Pennsylvania and Virginia; in addition, the mortgage bank plans to introduce them in California and New York this year. Your income from an IRMA depends on the size of the mortgage and the life expectancies of you and your spouse. (A detailed example appears in the table on page 118.) If you live beyond your life expectancy at the time you signed the mortgage agreement, your lifetime payments from an IRMA may exceed the value of your home. But if you die soon after you enter the program, your estate must repay the lender all of the monthly checks you received, with interest, plus all or part of the appreciation in the value of the house since the mortgage was signed. One variant on this type of loan, called a term reverse mortgage, is downright dangerous for most homeowners. With a term reverse mortgage, the lender makes monthly payments to a homeowner for a given period of time, typically seven years. At the end of that term, the homeowner must repay the loan, which often means selling the house. But, occasionally, the loans do make sense. For example, an elderly person who is on a waiting list for a place in a nursing home might take out a term reverse mortgage to meet expenses in the interim.

SALE-LEASEBACKS Helen Jordan, 79, sold her Marin County, Calif. home in 1984 to an investor for $92,400. She received a down payment of $25,000 and granted the investor a 13-year mortgage that pays her $825 a month. Just over $400 goes for the rent she pays to the investor, who qualifies for tax benefits because of the house's status as a rental property. The rest supplements her income from Social Security and the violin lessons she gives to local children. The mortgage payments will stop in 1997, when Jordan is 89. To ensure that her income continues indefinitely, she took the precaution of investing $6,800 from the down payment in a single-premium deferred annuity, which will begin paying her $825 a month when the mortgage payments stop. Meanwhile, the lease limits her annual rent increases to 2%, and she has managed to set aside some money for her heirs. ''I live here just as if it were my own home,'' she says. ''It's still my place.'' With a sale-leaseback, the buyer generally agrees to a 10% to 20% down payment and 15-year mortgage, and he also covers the cost of property taxes, insurance and maintenance. A sale-leaseback arrangement with a 10% down , payment and a 15-year mortgage on a $250,000 house might generate $32,000 in income to the seller, who would pay about $21,000 in rent during the first year. The income would remain constant, but the rent might climb to about $36,000 by the end of the mortgage term. Like Helen Jordan, you probably should invest part of the down payment in a deferred annuity so that you will continue to receive income should you outlive the mortgage. Finding an investor to take part in a sale-leaseback may be difficult, unless your children or other family members can afford to make the investment. Either way, enlist the help of an experienced attorney. Local bar associations and real estate boards might recommend professionals who can help you structure a typical deal for $1,500 to $2,000. For $35, the National Center for Home Equity Conversion (110 E. Main St., Madison, Wis. 53703) will send you its brochure Sale Leaseback Guide and Model Documents.

CHARITABLE DONATIONS If you can't find an investor to do a sale-leaseback and you have no children, you might try a school, hospital or charity. They will sometimes grant you a lifetime annuity in exchange for a remainder interest in your property. You continue to own it, but when you die it's all theirs.

ACCESSORY APARTMENTS If you have rooms to spare in your home, you might consider turning them into an apartment that you can rent out. Before you do anything, find out if the zoning regulations in your community permit such an arrangement. If so, ask a contractor to estimate the cost of renovation and real estate agents how much rent you will be able to charge. Ask your local agency on aging if there is a household matching service, which helps bring people with extra rooms together with prospective tenants, in your area. The service might help you find a suitable tenant; otherwise, try real estate agents. The book Creating an Accessory Apartment (McGraw-Hill, $16.95) by Patrick H. Hare and Jolene N. Ostler includes a sample lease and other useful information. While you are weighing these options, give careful consideration to the emotional factors as well. Anything that makes you uncomfortable is not worth doing, no matter how smart it is in dollars and cents.

This article is adapted from Family Wealth, a MONEY guide to retirement planning and living, available for $3.95 on newsstands or by writing to Family Wealth, Box 999, Radio City Station, New York, N.Y. 10101.

BOX: Check It Out / Questions to ask about an IRMA

Before deciding whether an Individual Reverse Mortgage Account is for you, consider: -- What are the monthly payments? Will they adequately add to your income? Remember that, over time, your expenses will increase but your payments will not. Can you rely on other assets to take up the slack? If not, look to a more lucrative strategy, such as trading down. -- How long do you intend to live in the house? If you plan to move within five years, the costs of an IRMA will be exorbitant. -- Are you likely to outlive your actuarial life expectancy? If so, an IRMA might be a bargain. But if you are in poor health, there is considerable risk that the loan's cost to your estate will outweigh the benefits it provides to you during your lifetime. -- Do you have children or other heirs to consider? Discuss your plans with them, since any repayment of your loan, as detailed in the accompanying story, will come out of your estate. You can ensure that you and your heirs always retain some equity in your house by exempting a percentage of its value from the transaction. But then you must settle for lower monthly payments from the lender. -- How much is your house likely to appreciate? If the prospects for appreciation are poor, an IRMA may prove to be relatively inexpensive. But if you are in a hot housing market, remember that you will give up part or all of the profits to the lender. In that case, consider whether you can afford to accept lower monthly payments and retain a greater share in the potential appreciation. -- Do you plan to make major improvements to the house? They will increase its value, all or part of which will go to the lender.

CHART: TRADE-DOWN

Additional Annual Home equity Year income housing costs and principal

1 $13,500 $3,200 $254,000 5 13,500 3,744 271,665 10 13,500 4,555 298,024 15 13,500 5,541 330,094 20 13,500 6,742 369,112 25 13,500 8,203 416,584

The couple get the biggest payoff if they sell the house and buy a smaller one for $100,000. Then they can invest their $150,000 gain in a diversified portfolio of investments, in this case yielding 9%. The income will more than cover their housing costs.

REVERSE MORTGAGE

) Additional Annual Home equity Year income housing costs and principal

1 $5,676 $8,000 $223,312 5 5,676 9,359 185,293 10 5,676 11,386 106,979 15 5,676 13,853 0 20 5,676 16,855 0 25 5,676 20,506 0

The couple can take out an Individual Reverse Mortgage Account, which pro vides payments of $5,676 a year for life. If they live for at least 15 years, their estate will owe the lender an amount equal to the home's value. (For details, see the accompanying story.)

DO NOTHING

Additional Annual Home equity Year income housing costs and principal

1 0 $8,000 $260,000 5 0 9,359 304,164 10 0 11,386 370,061 15 0 13,853 450,236 20 0 16,855 547,781 25 0 20,506 666,459

If they stay put and leave their equity intact, the couple will retain the full value of their property, which increases by 4% a year in our example. But they will need income from other sources to meet rising costs, including mainte nance, insurance and property taxes.

CREDIT: WARREN ISENSEE SOURCES: HOUSTON ASSET MANAGEMENT; AMERICAN HOMESTEAD CAPTION: Why trade-downs work best The tables below show three options available to a 65-year-old couple with a mortgage-free house worth $250,000. DESCRIPTION: See above.