SHE WANTS TO BE AN ARTIST, BUT OWES

In Alberta, a woman we’ll call Martha has devoted much of her life and money to caring for her brother — we’ll call him Sam — whose spinal problems have left him disabled and unable to work. Martha works for local government as a mid-level manager. It’s a job she dislikes and would like to quit, but it pays her bills and some of Sam’s. She paid for half the cost of his condo by what amounts to taking on his mortgage, ensuring he would not have to pay that cost. Her goal was to assure that he would have money left over each month for groceries and other necessities.

Martha feels trapped. Now 54, she would like to quit her job to become an artist. “I want to pursue my goal of becoming a painter, though that may be just a dream at this late juncture. Can I quit at 55?” she asks.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Martha.

“The problem is that she can’t afford to carry her expenses until her new career takes off, which could be a long time,” Moran says. “On the plus side, her two children are grown and financially independent. (But) with only about $67,200 equity in a rental property and financial and real estate assets of $293,626 able to generate retirement income, she can’t afford to quit a job now that supports two homes and provides credits for her employment pension.”

PRESENT FINANCES

Martha is not without means. She earns $85,000 a year. Her investment property generates a net annual return of about $4,570, making her total, pre-tax income $89,570. After paying 26 per cent average income tax, she brings home about $5,525 a month.

She has $827,126 in total assets. One piece, a $162,500 half-interest in her brother’s condo, is essentially an expenditure rather than an investment that can earn a return. Sam paid for his half out of cash he saved before illness ended his working life. Martha borrowed $150,000 for her half. Her part has been paid down to $142,300. That leaves her financial assets — her RRSP, tax-free savings account and some cash — for a total of $143,626.

Against those income-producing assets are debts, which total $227,568, and consist of $225,068 in mortgages and a $2,500 RRSP loan. Her net worth is $599,558. Real estate comprises 83 per cent of her total assets and 99 per cent of her debts are for her properties. She owns her own home outright.

There are ways to lighten the burden of Martha’s property, Moran says. Best bet: sell the rental condo. It brings in rental income of $12,000 a year, less $2,309 annual interest on the loan (not including addition to her equity), $4,840 taxes and condo fees and $280 insurance, for net income of only about $4,570 a year. That is a 6.8 per cent annual return on her equity, which is not bad, but not good either, given that she has risks of tenant damage (not covered by a reserve for maintenance), vacancy and a chance of having to pay higher interest when her 2.8 per cent mortgage rolls over for renewal in just six months.

Were Martha to sell the $150,000 condo, she could use the net proceeds — say $143,000, less the $82,768 mortgage — and emerge with $60,232 for investment. She could get four per cent from various dividend-paying Canadian stocks and she could invest in a low cost exchange- traded U.S. or Canadian stock index fund or a global stock fund. These investments would reduce her excessive concentration in property. Were she to put $36,000 of the money into her RRSP over time, at about $5,000 a year, and take a tax refund of about $11,500, and put the remaining $24,232 into her TFSA, the gain would be tax efficient, Moran notes.

Sam’s condo provides Martha with equity of $20,200. She has no financial return for the investment, but the $1,654 monthly accelerated mortgage payment she makes is about more than money. Her brother pays the monthly condo fees and half the tax. It should be left in place, Moran advises.

RETIREMENT FINANCIALS

If she waits to retire, Martha can receive $2,000 a month from her employer from age 60, or $2,400 a month — $28,800 a year — if she retires at 65. Her Canada Pension Plan contributions will entitle her to about 75 per cent of the present maximum of $12,780 or $9,585 a year at 65. She should not give up 36 per cent of it by starting CPP at 60, Moran says. At age 67, Martha will be eligible for full Old Age Security of $6,778 a year in 2015 dollars.

Martha has a present RRSP balance of $137,614. She can use her $5,449 TFSA balance for the RRSP contribution this year, producing a refund of about $1,700 in her 32 per cent marginal tax bracket, and increasing her RRSP balance to $143,063. The $1,700 refund would be sufficient to pay off most of her $2,500 RRSP loan outstanding balance. The remaining $36,000 to be contributed to the RRSP at a rate of $5,000 a year would eventually push the RRSP to an approximate value of $179,063. Allowing for three per cent annual growth after inflation, she would have $242,500 in RRSP capital at 65.

The enriched TFSA would have the $24,232 from the sale of the rental condo and $220 a month of continuing contributions. At age 65, the TFSA, growing at three per cent a year, would hold $65,200. The sum of RRSP and TFSA capital, $307,700, if paid out as an annuity so that no capital remained after 30 years would provide an annual income of $15,240, of which $4,225 would be nontaxable TFSA funds.

Added to her $28,800 age 65 job pension and $9,585 CPP, she would have annual retirement income of $53,625 and, after 16 per cent average tax, $3,754 a month to spend. At 67, OAS at $6,778 a year would bring gross annual income to $60,403, or and $4,228 a month after tax at the same rate.

Her present expenses and allocations, $5,525 a month, would decline by $1,654 with her brother’s mortgage eliminated within eight to 10 years, depending on what interest rate she obtains when that mortgage is up for renewal in 2016. Her expenses would then be $3,871 and supportable with her retirement income. Assuming she sold her income property, its monthly costs of about $840 plus $380 paid to equity, would also be gone, leaving her net reduced costs at $2,651 a month. She would have a comfortable surplus of after-tax income over reduced expenses with which to travel and, eventually, replace her present 2003 clunker.

“Retirement at 60 is possible, but she would have little extra income for unexpected costs,” Moran says. “If she craves time off for painting before 65, a sabbatical would preserve her retirement.”