Unlocking the cottage could be key to Ontario woman’s retirement hopes
A woman we’ll call Evelyn, 52, works for a local government in northern Ontario. She has about $1.1 million in two RRSP accounts, about half from years of saving and half from a former spouse, and a $60,000 Tax-Free Savings Account. Her plan is to retire in five years at age 57. Her issue — can she afford to move from a rented house at $1,300 per month with all utilities included to buying a house in a price range of $280,000 to $350,000?
She could buy the home in which she now lives for $359,000 and then rent out the basement for $1,500 per month — a sum sufficient to pay anticipated mortgage costs. She also has a cottage with an estimated value of $285,000. It would need much work to be a year round home. At present, her take home income is $4,500 per month.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Evelyn. “Her financial assets and her forthcoming civil service pension can support a comfortable retirement. The issue is balancing the capital cost of a home of her own with the effect of reducing her savings to buy it,” he explains.
PAYING FOR A HOME
If she were to buy a $400,000 house, then her monthly cost would include property taxes of an estimated $300 per month, utilities and insurance at $300 per month and interest at an estimated $1,000, for a total of $1,600. That would be almost fully offset by $1,500 rent from her basement tenant. If the suite takes up half the house, half the utilities and taxes would be deductible from rent. The new house would pay for itself. With these assumptions, she would live for free, Moran concludes. Even if mortgage interest were to double, which is unlikely in the next few years, ownership would be cheaper than continuing to rent.
Where to get the down payment is problematic. Her assets are $285,000 in her cottage, $1,083,265 in RRSPs, and $60,000 in a Tax-Free Savings Account. A homeowner before her recent separation, she cannot use the RRSP Home Buyer’s Plan, but she can put a mortgage into her RRSP to fund the house she wants to buy. There is red tape to do this, but if she charges her RRSP an interest rate of, say, 2.5 per cent, she would be accepting a low return and tying up her money. She could charge herself a higher rate, but it’s just juggling. Better to borrow from a conventional lender and keep her retirement income flow intact, Moran suggests.
An alternative is fixing up the cottage. Evelyn could use her $60,000 TFSA and then set up a home equity line of credit to pay for further upgrades if needed, but it would not have a tenant. Either buying a house and having a tenant or enhancing the cottage for her own use would work. Which to pick? Taking on a large mortgage debt at age 52 with one paycheque and artificially low borrowing costs to buy the house is not prudent. The cottage is the less challenging alternative. It is the better choice, Moran concludes.
RETIREMENT INCOME
When Evelyn retires at age 57, she will have two sources of income. First, there will be her investment income. If the present total of $1,083,265 is left to grow at three per cent after inflation for five years to her age 57, it would become $1,255,801 assuming there are no further RRSP contributions which, in any event, are limited by the pension adjustment to pretty much what she and her employer add to her defined benefit pension each year. If this sum, still continuing to grow at three per cent after inflation, were paid out for the next 38 years to her age 95, it would provide $55,832 a year before tax.
Evelyn’s civil service pension, including a $3,890 annual bridge to age 65, would begin to pay her $22,885 at the start of her retirement. The rules and amounts are complex, but we’re close with this number based on her employer’s pension calculations.
The sum of investment income and pension income would be about $78,720 before tax. Allowing a 20 per cent average tax rate at this point before various age credits can be applied, she would have $5,250 a month to spend. That is more than her present take home income.
At 65, her employment pension would drop by 17 per cent to $18,995 per year. Her investment income would be unchanged. Her Canada Pension Plan benefits at 70 per cent of the present $13,610 maximum would add $9,527 a year and Old Age Security would provide $7,040 per year. Her total and permanent retirement income would be about $91,400 before tax. Adjusted for age and pension credits, she could pay tax at 22 per cent and have $5,940 per month to spend to age 95. Thereafter, with her investments exhausted, she would have a home she could sell to obtain income for her needs in late old age.
INVESTMENTS NEED GROOMING
With cost controls on her retirement house or cottage, Evelyn can have more money in retirement than today. She has two RRSP portfolios. They look like night and day, Moran says.
One, self-directed by Evelyn, is a collection of stocks with a value on Sept. 30 of $571,129. It contains 11 stocks and three mutual funds. An electrical power company is 29.7 per cent of the portfolio. There are energy companies, a 16.3 per cent weight in a pipeline, a real estate trust and a bank. Two small cap energy companies add up to a combined loss of $79,582. It is an energy portfolio with a bit of financial services. It is not diversified and it is not appropriate, Moran explains.
A second RRSP portfolio was established early in 2017 with an adviser. It had a recent value of $512,136. It is diversified with energy, financial services, telcos, power generators, pipelines, several profitable large cap U.S. stocks, excellent corporate bonds and a good fixed income mutual fund. She could shop for independent portfolio management at what could be half the one per cent management fees plus embedded mutual fund fees she pays, Moran suggests. Evelyn would do well to have her advisor review the first portfolio.