MORE THAN A HOLIDAY HOME
Couple must turn cottage into income for retirement
A couple in British Columbia we’ll call Susan and Nate will retire within a few years. Nate, who is 60, closed his architectural drawings company this year. Susan, 58, is a health care professional and continues to work 80 per cent of full time. Together, with her salary and their modest investment income, they bring home $4,816 a month. Tax refunds from Susan’s RRSP contributions, $7,920 a year, add about $250 a month to their monthly income, raising it to $5,066. Susan is a dual U.S./Canadian citizen. They defer house property taxes via a B.C. program that charges persons over 55 simple interest of 0.7 per cent per year repayable when the house is sold.
The soaring B.C. property market gives their house a value of $1.7 million. It is their largest asset, representing 65 per cent of their total wealth. It has a tax-free capital gain over the few hundred thousand of price plus major repairs, none of it taxable. Two grown children live away from home.
“We anticipate selling our home,” Susan explains. “That would give us $250,000 if we stay in our community and $500,000 if we move out. But would it be wise to use our current cash of just over $200,000 to buy a $400,000 condo and have one child as a tenant paying the market rent of $1,500 a month?
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. to work with Susan and Nate. His analysis is crisp: “They have the net worth to retire, but 78 per cent of their net worth is in real estate which yields zero net income.”
RESTRUCTURING ASSETS
Let’s look at the idea of buying a $400,000 condo for a child who will pay $1,500 monthly rent. After a $200,000 down payment, a $200,000 mortgage would cost $817 a month for the mortgage or about $9,800 a year, condo fees of $3,600 a year and insurance of $500 a year and perhaps $2,000 a year for upkeep and accounting. That adds up to $15,900 compared to rental income of $1,500 per month times 12 months or $18,000 a year. Their net income would be $2,100 a year or a 1 per cent return on their capital, plus or minus market value changes. The numbers could change, of course, but it is clear that the return is not attractive considering there might be periods of vacancy. Moreover, rental income is fully taxable, Moran notes.
They spend just two weeks a year in their cottage and offer it for rent during the remainder of the year. On an annual basis, after taxes and upkeep, the cottage is a wash — but is it a good use of $300,000 of capital? If they realize $285,000 after 5 per cent preparation and selling costs (and pay minimal capital gains tax, due to Nate’s low income and Susan’s RRSP deduction room) on a $200,000 cost base, the sum, invested in large cap Canadian shares with 6 per cent return less 3 per cent inflation, would produce $8,550 a year or $712 per month. The income would boost their travel budget and allow them to take holidays in the cottage when they like, paying another owner. If they pay their own peak season rate of $2,900 per week for two weeks — or $5,800 total — they would be far ahead.
RETIREMENT INCOME
When Susan joins Nate in retirement, which is going to be within a year or two and certainly before 60, their incomes will be composed of a $1,500 monthly defined benefit pension for Susan plus a bridge of $500 a month to her age 65. They will have income from their RRSPs, which currently total $370,000 and about $205,000 cash. Nate has a $35,000 balance Tax-Free Savings Account. Susan has no TFSA because the U.S. does not exempt earnings within TFSA from tax.
At 65, Nate can expect $768 a month from the Canada Pension Plan or $492 at 60. Susan would get $854 from CPP at 65 or $546 at age 60. When she retires, she will also get a one-time benefit for sick days not taken of $13,340 and severance pay of $8,450 — total $21,790. Each will receive Old Age Security at 65 of $6,942 per year or $579 per month in 2017 dollars.
Nate and Susan have $612,800 of present financial assets.
If Nate takes $17,000 from $204,800 cash and tops up his TFSA, he would have a balance of $52,000, the 2017 maximum. That cash, earning 3 per cent a year after inflation to Susan’s age 90 would generate $2,600 a year or $217 a month. The property sale proceeds annuitized for 32 years to Susan’s age 90 at 3 per cent a year after inflation would add $12,000 per year or $1,000 per month to pre-tax income.
Remaining cash of $187,800 and RRSP balances of $373,000, earning 3 per cent after inflation, could provide $767 and $1,525 per month respectively, under the same terms.
After age 90, if they had no more money, they would still have their house that they could sell.
Adding up retirement income sources to age 65 with the assumption that neither CPP nor OAS is taken before 65 by either partner and that Susan receives no Social Security benefits, then they would have total, pre-tax income of $2,000 a month from her work pension, $217 from Nate’s TFSA, $767 from invested unregistered cash, $1,525 from RRSPs, and $1,000 from the cottage sale. That’s $5,509 per month before tax.
After splits of eligible income, they would pay perhaps 12 per cent average tax and have about $4,850 a month to spend to support their present budget of $4,816 a month. However, with no RRSP savings of $660 a month and $450 present car fuel and repairs reduced by half with just one car, their budget would decline to about $3,900 a month.
At 65, their income would lose Susan’s $500 monthly bridge but gain $1,622 in total from CPP and $1,158 from OAS for total pre-tax income of $7,790. No tax would apply to TFSA payouts, so if eligible income were split and age and pension income credits applied, after 12 per cent average tax they would have about $6,860 monthly after tax income. Selling the cottage provides vital extra cash and wiggle room for unexpected expenses, travel and a new car from time to time, Moran notes.