Selling stocks to pay down mortgage a false economy for couple
At their respective ages of 52 and 49, a B.C. couple we’ll call Hank and Jamie are prospering. Hank, a management consultant, brings home $7,084 a month. Jamie, a parttime translator, brings home $1,700 a month after tax. They have two children ages 17 and 20, each in university. They would like to retire in eight years.
The $314,000 mortgage on their $1.2 million house costs $ 2,500 a month at 2.1 per cent. It has a dozen years to run. If rates rise to 6 per cent, the monthly payment would go up to as much as $3,000.
Hank and Jamie would like to retire with a combined, pre-tax income of $95,000 a year. That would be about 60 per cent of their present gross income. Their $314,000 outstanding mortgage will not be paid until Hank’s age 64 if the present schedule is maintained.
RETIREMENT STRATEGY
Family Finance asked Caroline Nalbantoglu, head of CNAL Financial Planning Inc. in Montreal, to work with Hank and Jamie. “This case is complex in its details but the base for a solid retirement is in place,” she says.
Their taxable portfolio has a $ 734,000 value. They could sell stocks to pay off the mortgage, but in this case, given a portfolio generating 4 per cent with reduced taxes on dividends and low taxes on capital gains and the $314,000 mortgage with a 2.1 per cent interest rate, it would be a false economy to sell. The loss of after-tax investment income would just about match interest saved. Stock price gains or losses are, of course, a wild card. Best bet — keep the stocks in nonregistered accounts. If they retire in eight years, they can look at the situation again and review the outstanding balance. If interest rates and payments are too high, they could re-amortize.
An alternative is to sell some stocks for cash to pay off the mortgage, then repurchase or buy other stocks with a loan against their house. Mortgage interest will then be tax- deductible. As well, B.C. makes property tax deferral at a present cost of 0.7 per cent a year with no compounding available to persons 55 and older, subject to a lien on the property until the deferral is repaid. It would save them $3,500 a year.
ESTIMATING RETIREMENT INCOME
Currently, the couple’s taxfree savings accounts total just $5,000, with all of it belonging to Hank. Hank thus has $ 47,000 of TFSA room, Jamie has $ 52,000. They could use $99,000 from their $ 734,000 non- registered stocks and pay capital gains tax due to fund the contributions and use up TFSA space. In future, they should invest the allowable maximum in each TFSA each year, Nalbantoglu suggests. Assuming that they bring their plans up to the allowable limit, $52,000, and contribute $11,000 total each for the next eight years, the plans, growing at 3 per cent, will have a value of $232,500. That sum, paid out for the next 33 years to Jamie’s ago 90 would generate payments of $ 11,200 per year.
Hank has $ 442,000 in his RRSP, Jamie $80,000 in hers. In future, he can maximize his RRSP contributions and get a 38 per cent tax cut. RRSPs can be transferred without tax to the surviving partners at the death of the first. Pension splitting from RRIF income is also allowable under current law. But it is wise to try to equalize the plans, for a future government could impair pension income splitting or even phase it out.
Hank has a defined contribution pension plan, essentially a company RRSP. He has just started contributing to it. He puts in 4 per cent of his salary with a full match by the employer. That means he adds $10,400 per year including his own private RRSP contribution of $3,600 a year. By the time he is 60, his plan, including his present RRSP balance of $ 442,000, will have $652,000, assuming a 3 per cent rate of growth after assumed 3 per cent inflation. Jamie will have $ 133,000 in her RRSP, Nalbantoglu estimates. The total will be $785,000. The couple’s total RRSP and DC plan capital, calculated to pay for the 33 years from Hank’s age 60 to Jamie’s age 90 with growth at 3 per cent after inflation would support income of $37,800 a year.
In ei ght years, t heir $ 734,000 present value taxable portfolio with 3 per cent annual growth after inflation less $99,000 to fund TFSAs, net $635,000, and no further contributions will grow to $ 804,400 and would then support payments based on continuing 3 per cent annual growth after inflation for the next 33 years of $ 38,800 a year.
Adding up the sums, in eight years, the couple would have $87,800 pre-tax income when Hank is 60. After 16 per cent average tax, they would have about $4,680 a month to spend.
ADJUSTING COSTS AND BOOSTING INCOME
They could reduce property taxes via a B.C. plan that allows seniors to borrow tax from the government at 0.7 per cent a year current rate, reducing the cost to about $ 25 a month. They could trim perhaps $600 a month from other costs when their children have moved out. Their expenses would then be about $ 7,900 a month until the mortgage is paid off, then $5,400 a month. They could finance the deficit by drawing down their taxable portfolio. Early application for CPP, an estimated $13,370 a year for Hank, would cost 7.2 per cent a year and leave only $8,557 a year, slashing the base for the couple’s largest fully indexed pension source. Better to use other assets to cover the deficit, the planner says.
At 65, both will get full Old Age Security of $ 6,942 per person. By then, their mortgage will be paid in full. Jamie would have an estimated CPP benefit of $2,674 a year, Hank the full benefit of $ 13,370 at 2017 rates. Total income would then be $117,730 a year before tax or $8,240 a month after estimated 16 per cent average income tax based on age and pension income credits. That easily tops their goal of $95,000 a year.