Ditching a money-losing condo will help this couple solidify their retirement plans
A couple we’ll call Lou, 47, and Martha, 46, live in B.C. Both work at the leading edge of technology, Lou in management for a sales operation, Martha in a consulting role in marketing. Their jobs are demanding. They have two children, one in elementary school, the other starting high school.
With combined gross after-tax income of $10,660 per month and net worth of about $1.7 million, they look forward to retirement in 18 years when Lou is 65. They are heavily dependent on the future of the property market. Four-fifths of their approximately $2.36 million of assets is their $1.4 million house and a $480,000 rental condo that loses money every month.
Their problem is a time squeeze. Their younger child will not graduate from high school until Lou is 58. They want to buy a larger house, adding $250,000 to $500,000 to their present home’s $1.4-million price tag. “How much can we spend on a house before we jeopardize our plan to retire with $85,000 after tax income?” Lou asks.
Family Finance asked Graeme Egan, head of CastleBay Wealth Management Inc. in Vancouver to work with the couple.
“Their biggest concern is if they can be financially independent in 18 years and so not have to sell their house and downsize,” Egan explains.
MANAGING THE PROPERTY ALLOCATION
Their revenue property is problematic. From gross rent of $1,542 per month they deduct $1,083 for their mortgage and condo fees plus manager’s fees and taxes of $500 per month. Their return is actually a $41-per-month nominal loss, though a little more than half of the mortgage payments add equity. They view rent as a means of reducing the cost of holding the property, with a future capital gain making up for losses along the way.
An alternative would be to sell the property for an estimated $480,000, pay off the $215,000 owing on the mortgage, net $241,000 after five per cent selling costs, and invest that money in a larger house with space for a tenant.
Putting the proceeds of the sale of the rental plus their present home equity of $980,000 toward the price of a larger, $1,650,000 home, would leave them with a $429,000 mortgage.
They still owe $9,000 on their homebuyer’s loan, raising the cost to $438,000 when paid off, though the transfer back to the RRSP is really a wash. We can round off to $450,000 for closing costs and fees.
They could get a 25-year, 3.5 per cent mortgage with payments of $2,250 per month, a sum less than their present monthly mortgage payment of $2,600, plus the $1,083 they pay for the rental condo. On mortgages alone, they could save $1,433 per month and, if they shop the deal right, the bigger house would have a rental unit.
EDUCATION FUNDING
The immediate investment need is to continue funding the family Registered Education Savings Plan. They already contribute the maximum for qualification for the Canada Education Savings Grant, $2,500 per beneficiary per year, which makes the plan eligible for the lesser of $500 or 20 per cent of contributions. The plan, with $65,000 of assets, is growing at $5,400 per year from contributions and $1,000 from the CESG. If this inflow continues and produces a 3 per cent return after inflation, then there would be about $70,000 for each child for costs toward postsecondary studies, Egan estimates.
RETIREMENT FINANCE
Retiring in 18 years with an $85,000 after tax income is feasible. Lou and Martha are each entitled to a foreign government pension, which works out to $4,000 each. Martha has a foreign work pension that will pay her $8,800 a year.
At present, Lou and Martha have a total of $288,000 in their RRSPs. They contribute a combined total of $725 each month to their plans, fully matched by their employers. They therefore contribute $17,400 in total to their plans. If this inflow continues for 18 years to the time that Lou is 65, they will have 18 and 17 contribution years, respectively. Therefore in 2036, their plans will total about $910,000. If those plans pay out all of their capital and income over the next 31 years to Martha’s age 95, they would provide $45,500 per year.
The couple has a combined TFSA balance of $25,000. If they continue to add $250 per month to each plan, $500 per month total, and if the plans grow at 3 per cent after inflation for the next 18 years, they would have a balance of $183,000. That sum, if paid out on the same terms for the next 31 years would generate income of $9,150 per year.
We need an assumption for rental income from the home they plan to buy. If they charge rent of $1,600 per month and deduct operating costs of just $400 per month for utilities and repairs on the assumption that a new mortgage would be paid in full or close to it by retirement, the new rental would produce taxable rent of $14,400 per year.
At age 65, Lou and Martha will have resided in Canada for 35 years after age 18, half a decade short of the 40 years required for full Old Age Security, currently $7,040 per year per person.
Their OAS benefits will therefore be $6,160 each. Their estimated Canada Pension Plan benefits based on their job history in Canada will entitle Lou to $557.50 and Martha to $1,120 per month.
Adding up the numbers and assuming that Lou and Martha turn 65 within a 12-month period, their retirement income will comprise $8,000 foreign government pensions, $8,800 foreign company pension, $45,500 annual RRSP payouts, $9,150 TFSA payouts, annual taxable rent of $14,400 in their new home and combined OAS and CPP benefits of $20,130 per year. The total of these income streams, $105,980 per year, less $9,150 non-taxable TFSA equals $96,830 taxable per year.
With eligible pension income split and income taxed at an average 13 per cent rate before inclusion of TFSA income, the couple would have $93,400 to spend each year. Time adds risk, but they should be able to beat their $85,000 annual after-tax target, Egan says.