With two condos and no plan, the clock is ticking on this couple
Two men we’ll call Matthew and Geoff, both 58, make their home in southern Ontario. They work in publishing and bring home a combined after-tax monthly income of $8,504. Their financial lives are complex. They have two rental condos worth about $1.3 million, about $450,000 of debts, and no present chance of retiring in comfort. They desperately need a fix.
Their RRSPs total $113,220, they have no TFSAs and the rental properties are inefficient income generators. They have no target retirement income, but they know they have to straighten out their finances in the seven years to when they want to quit at age 65.
They get income from one condo and rent the other to an elderly family member for virtually nothing, absorbing costs of ownership, and pay interest on personal loans and mortgages. They live in somebody else’s condo for which they pay $21,600 yearly rent. That’s more than the $19,310 per year they receive in net rent from their own rental units.
“We don’t know what to do,” Matthew says. “Keep one condo, keep two, use the return from one to reduce the debt and amortization on the other, or sell both?
MANY OPTIONS
To sort out the choices of which condo to keep, which if either to sell, and how to structure retirement income, Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the men.
“There are many variables here and the future of interest rates, taxes and maintenance are unknown,” Moran says. But there is one immediate change that can set them on the right path. “Given that renting for personal use costs them $191 a month more than what they get as landlords, they should take over one unit and live in it. Then stop paying rent.”
Matthew and Geoff regard their real estate holdings as the basis for retirement, but making it happen will take work. Currently, the condos are worth about $750,000 and $550,000 respectively.
While they could move into the first condo, the couple would be happy downsizing to a unit with a price tag closer to $600,000. Moran says they should make that move, and shift the existing mortgage to the new condo.
Tax on the sale would be slight for they lived in the unit, for which they paid $375,000, for four of the last six years. Tax rules give an additional year of occupancy, so the condo as investment would be just a sixth of the gain and the tax on half of that gain, as the computation works, would be $8,400 depending on how the gain is apportioned to the men and each one’s tax rate.
They can then use the $130,000 cash difference realized after selling costs to pay off $69,793 of personal debts. Then $42,500 of the remaining cash can reduce the existing $310,000 mortgage to $267,500.
FUTURE VALUES
The remaining condo, with a value of $550,000 brings in zero monthly rent. The family member who lives in it is older and pays all expenses except for half the mortgage. His share is $525 and $100 of tax. The $550,000 property has a $70,000 mortgage, and $480,000 equity.
Eventually, they can sell the rental condo. The aftertax rent is not sufficient to pay their mortgage cost. Sale proceeds would eliminate their debt and leave some cash — about $163,000, which could top up RRSPs and even fund TFSAs.
ADDING UP FUTURE INCOME
Their RRSPs currently total $113,320 invested in a variety of mutual funds. Matthew has $15,170 of RRSP contribution room. His net income totals $65,000, allowing him to make good use of his of contribution space. Geoff ’s earned income, about $37,000 a year, makes RRSP contributions less tax-efficient and not worthwhile, Moran explains.
If Matthew contributes $15,170 to fill his RRSP space and then adds $11,700 per year for seven years, the present balance of the two accounts, $113,320 as above, growing at three per cent after inflation will rise to $247,677 in 2018 dollars when the men are 65. Spent over the next 25 years, this capital, still earning three per cent after inflation, would generate $14,224 per year at which time all capital and income would be exhausted.
If the men set up TFSA accounts and fund them with money left from sale of the rental property plus money they no longer use to pay their personal loans and lines of credit, then their accounts would have a balance about $62,000 in seven years. If that sum, generating three per cent after inflation is paid out on the same basis for the next 25 years, it would generate $3,600 per year.
The men will be eligible for CPP at age 65: Matthew $9,360 per year and Geoff $3,588 per year. Each can receive Old Age Security at 65 in a current amount of $7,160 per year. TFSA income would contribute $3,600 per year. Their incomes would be below $46,000 each, so the Canadian dividends would be tax free courtesy of the dividend tax credit, Moran notes.
With these numbers, the men would have taxable income of $41,492 plus $3,600 TFSA income, total $45,092 per year. With income split, their tax rate would be near zero. They would have about $3,800 per month to spend, more than current core expenses — present spending less mortgage costs, loan repayment, some condo costs and rent. If the men reduce entertainment and travel costs of $1,500 per month, they would be able to live within their means. When the occupant of the zero return condo leaves or passes on, the property can generate more income or be sold.