B.C. couple needs to turn paper wealth into retirement cash
Acouple we’ll call Bill, 63, and Mary, 55, live in B.C. They bring home $5,677 per month from a small transportation business they own plus rental income from a basement suite in their house and a rental condo. They want to work five years, then sell the rental condo and use the money for retirement with more travel. Their child, 18, lives with them and will start university in fall.
On paper, despite having a modest income, the couple is wealthy. Their home has an estimated market value of $1.5 million and the condo of $430,000. They have $379,729 in financial assets and two cars each about 10 years old. The plan — sell one property and invest the proceeds to replace job income that will cease, then live as they do now.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Bill and Mary. “They are hardworking and down to Earth, but there is a planning problem in that Mary, being eight years younger, has a much longer life expectancy.”
A PARADOX OF WEALTH
The problem is to translate their wealth on paper to future sustainable income. They are millionaires due to the inflated price of their house and condo. That’s a fact of life in lower mainland B.C. real estate. The house and condo make up about 87 per cent of their net worth. Their home has a rental suite that generates rent of $1,185 per month. The condo rent is $1,300 per month before expenses are deducted. Those cash flows, a total of $2,485 per month before property tax, maintenance, insurance and condo fees which add up to $683 for both properties, easily pay the $896 combined mortgage cost and leave a tidy profit of $906 per month or $10,872 per year.
We have to dissect the cash flows for the two properties to measure their respective profitability. The condo’s mortgage cost is $165 per month. Insurance, accounting, condo fees and property taxes add $430 per month for total cost of $595 per month. Their net rent is thus $1,300 minus $595 or $705 per month. That’s $8,460 per year or two per cent of its $430,000 market value.
That is a modest return for the risks of ownership. They would do better to sell the property and invest in dividend stocks with an average return of 4.5 per cent. We will assume that they do that. The $430,000 sale price minus five per cent selling costs and the $24,872 outstanding mortgage would leave net proceeds of $383,628. The remaining mortgage for their house runs to when Bill is 80 and Mary 72, but they can’t afford to give up capital needed for retirement income.
Bill lived in the condo for eight years from 1989 when purchased to1997. Add a year for occupancy and fractional years, as CRA rules allow, so 10 out of 30 years of ownership have no capital gains tax. The remaining ownership subject to capital gains tax leaves exposure at $111,056. Assume a 20 per cent tax rate and the couple would pay about $22,200 tax. $361,400 could be invested, Moran estimates.
GENERATING INCOME
The couple has $326,202 in RRSPs. Bill’s income tax rate is too low to justify further RRSP contributions. If the balance grows at three per cent over the rate of inflation for five years, it will become $378,160 and support taxable income of $19,295 per year for 30 years to Mary’s age 90.
At age 65, Bill can expect $12,672 per year from CPP and Mary at 65 $3,072 from CPP. Each can get $7,217 from OAS at present rates.
Their TFSAs total $51,177. They add nothing at present. If the account grows at three per cent after inflation, it will become $59,328 in 2019 dollars in five years. If spent over the next 30 years to Mary’s age 90, it would generate tax-free income of $3,027 per year.
Capital liberated from the condo sale, $361,400, invested at three per cent per year after inflation for 35 years with the sale triggered when Mary retires at age 60 and running for 35 years to her age 95 would generate $18,000 per year and they would still have their house after age 90.
RETIREMENT BUDGETS
Adding up their income flows for the period from Bill’s age 65 to his age 68 (Mary’s age 60) based on the assumption of keeping the house and collecting $900 monthly, $10,800 annual net rent on the basement suite, they would have earned income of $7,200 per year for Mary and $24,000 per year for Bill, one Old Age Security benefit of $7,217 per year for Bill plus his Canada Pension Plan benefit of $12,672. Money made from condo sale capital would add $18,000 for a total of $79,889 before tax. TFSAs would add $3,027 per year. After 15 per cent average tax and no tax on the TFSA payouts, they would have $5,700 to spend each month. With no condo mortgage to pay and their child independent and not running up $300 per month in clothing, athletic and other costs they would break even.
From Mary’s age 60, both would be retired. They would have pre-tax income of $10,872 rent, Bill’s CPP of $12,672, his $7,217 OAS, $19,295 RRSP income, $18,000 from the house sale and $3,027 TFSA non-taxable income for total pretax income of $71,083. After 12 per cent average tax and no tax on TFSA payouts, they would have $5,245 per month to spend.
Once Mary’s CPP and OAS start to flow, their income would rise by $7,217 for OAS and $3,072 for CPP. Their total income before tax would be $81,372. After 16 per cent average tax and no tax on TFSA payouts, they would have $5,740 monthly to spend.
They hope they can add $10,0000 to their annual budget for travel costs. Renting out their house for several months while they are away could provide the needed income. The house will remain their largest asset, but reduction of its weight from 83 per cent to 67 per cent of total assets will provide more safety from shocks to the property market.