Can Ontario couple afford to buy a house in middle age and retire?
Amount couple has in cash savings $150K
In Ontario, a couple we’ll call Chuck, who is 45, and Leslie, who is 43, live in a rental apartment. They pay $2,000 per month which, they figure, would cover mortgage payments just as well. With Toronto house prices ascendant once again, the couple is eager to buy before they become even more expensive. They have $150,000 cash from selling their home last year. That could be a down payment on a $ 600,000 home. Their present take-home income is $8,750 per month.
“We wonder if we can afford to pay a large mortgage and save for retirement,” Chuck explains.
On the upside, there is the couple’s $150,000 annual pre-tax combined income, $8,750 per month after taxes. They save nearly $50,000 per year out of their income. But there are other issues. Each is self-employed, Chuck as a management consultant, Leslie as health-care professional.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple.
Their assets, other than $ 150,000 cash in the bank from sale of a former home, are $ 20,000 in RRSPS. They need to think about retirement savings as well as buying another house.
Predictions are fallible
Chuck and Leslie are at a nexus in financial and real estate markets. What financial assets may earn if invested in RRSPS or TFSAS or anything else other than GICS or just cash on account is unknowable. The stock market could continue to rise in its recent recovery or crash once again. Interest rates on bonds are very low though bond markets could still generate profits if interest falls further. Year to date, the broad Canadian bond index is up about eight per cent. Maintaining money for a down payment in an investment market characterized by high stock prices and falling bond interest rates has to be safety of principal.
It would not be prudent to risk their potential $150,000 down payment. Keep it in a GIC, he suggests.
Saving and investing
They need to beef up their RRSPS. Chuck has $ 20,000 in his, Leslie has no RRSP.
Respectively, they bring home $ 70,000 and $ 80,000 on a pre-tax basis.
Each partner could contribute to the RRSPS to bring down income. At the top of the first federal bracket, $48,000, Ontario rates jump from 24.15 per cent to 29.65 per cent, so they would be wise to ensure that neither fall below this level. Thus a $ 1,000 RRSP contribution generates an almost 30 per cent refund and keeps the taxpayer from paying even more.
Their mortgage could still be financed with cash in their bank accounts. If they can pay $ 2,000 to $ 3,000 per month for 22 years to the time Leslie is 65, they can afford a mortgage of about $500,000. A $500,000 loan at 2.5 per cent would require a monthly payment of $ 2,464. Property taxes might add $ 400 per month for total payments of $2,864 plus insurance and incidentals — say $ 3,000 as a round number. That’s more than the $ 2,000 monthly rent they now pay, but it is manageable on their income.
Migrating to home ownership makes sense in spite of the likelihood that today’s low rates will rise in several years.
By then, any mortgage balance will have been paid down and refinancing even at higher mortgage rates will be affordable.
If the couple buys a townhouse with a legal suite for rental, their net cost of ownership would be even less.
Assuming that Chuck and Leslie buy a home, their potential cost of $ 3,000 per month would leave them with $ 5,750 cash for allocations including their RRSPS based on total take-home income of $8,750 per month.
Their lender might require mortgage life insurance. Term life insurance usually covers the lender with nothing left for the owner. Chuck and Leslie would do well to shop for a 10- year level premium policy. They could get $ 500,000 of joint and firstto- die renewable life coverage for perhaps $ 700 per year.
Retirement planning
If Chuck and Leslie add $ 2,750 per month for 22 years to their RRSPS and if the balance grows at three per cent per year after inflation and fees, it would rise to $1,076,300 when Leslie is 65. That sum would support annuitized payouts for $53,300 for the following 30 years to Leslie’s age 95.
What Chuck and Leslie receive from the Canada Pension Plan is speculative at this point. They have two decades of earnings as a base for contributions. However, assuming that Chuck earns 100 per cent of the $ 14,110 present maximum for pensionable earnings and Leslie earns 88 per cent and that he defers taking his CPP for two years until Leslie is 65, they would have a combined sum of $28,900 per year.
Their OAS based on years resident in Canada between 18 and 65 would be $ 8,422 for Chuck assuming he waits to age 67 to start benefits and $ 6,479 for Leslie at 65, total $14,901.
Adding up sources of retirement income, they would have $97,100 per year before tax starting when Leslie is 65. Assuming they split eligible income, they would pay tax at an average 14 per cent rate and have $ 6,960 per month to spend. They would have a home of their own fully paid. With no further mortgage payments, their monthly expenses based on present spending with rent removed would be perhaps $ 3,000 per month depending on maintenance and property taxes, leaving a monthly surplus for travel, investment or donation to good causes.
Chuck and Leslie are frugal. Chances are that they would save aggressively even while paying off their mortgage. They have no TaxFree Savings Accounts now but could open them and contribute the maximum $ 6,000 per year or work out a catch- up series of contributions. It’s only reasonable to assume they would build TFSAS, but we won’t include any TFSA cash flow in our retirement projections.
Adding a house to assets in a market of strong property prices will generate capital gains, but the numbers are deceptive, for it is necessary to downsize, sell and rent, or move to a cheaper market to take gains and live as well.