Cou­ple needs to cash in on rental condo gains to make re­tire­ment work

Saskatoon StarPhoenix - - FINANCIAL POST - An­drew Al­len­tuck

Acouple we’ll call Steven and Amanda, 43 and 42 re­spec­tively, live in B.C. with three chil­dren ages 3 to 8. They bring home $10,936 af­ter tax each month and add $286 from the Canada Child Ben­e­fit, to­tal $11,222. A high-tech manager and a health-care con­sul­tant, re­spec­tively, they are typ­i­cal west coast in­vestors with a taste for real es­tate. Their $1,689,000 house and their $819,000 rental condo make up most of their $2.97 mil­lion to­tal as­sets. Their li­a­bil­i­ties are two mort­gages that to­tal about $1.13 mil­lion.

“Can we re­tire at 65 with our present stan­dard of liv­ing in­tact?” Steven asks. And can Amanda work only part time in or­der to get there?

Fam­ily Fi­nance asked Derek Mo­ran, head of Smarter Fi­nan­cial Plan­ning Ltd. in Kelowna, B.C., to re­view Steven and Amanda’s fi­nances and plans. “If these folks are to re­tire com­fort­ably, they will have to raise in­vest­ment in­come,” Mo­ran says.

Right now, their largest sin­gle in­vest­ment is the $819,000 rental condo with a $373,357 mort­gage. Their net worth, in­clud­ing RRSPs, RESPs, their own house and cash, less the two mort­gages, is $1,838,376. It’s very good for a cou­ple in their 40s with three kids, but 85 per cent of their to­tal as­sets are in two prop­er­ties. Iron­i­cally, their rental unit, while hav­ing ap­pre­ci­ated in value sig­nif­i­cantly, is not a good pro­ducer of cash.

ED­U­CAT­ING THE KIDS

The cou­ple’s first pri­or­ity in a chrono­log­i­cal sense is ed­u­cat­ing their three chil­dren. They have $28,600 in their Reg­is­tered Ed­u­ca­tional Sav­ings Plan. At present, they add $300 per month. To make the most of the Canada Ed­u­ca­tion Sav­ings Grant, they should con­trib­ute a to­tal of $625 per month or $7,500 per year. Then they will re­ceive the max­i­mum CESG, $500 per child, to make the fund grow at $9,000 per year.

When the kids, now 8, 6 and 3 are ready for post-se­condary ed­u­ca­tion, the fund, grow­ing at 3 per cent per year af­ter in­fla­tion, will have about $31,500, $39,700, and $52,950 for the kids from youngest to old­est. It would av­er­age about $41,400 for each child with the par­ents en­sur­ing equal sums for the kids. It would cover four years of tu­ition at most B.C. post-se­condary in­sti­tu­tions and be enough if the kids live at home.

If Steven and Amanda trim other spend­ing, cash on hand and, later, sav­ings on day care, will sup­port higher RESP sav­ings.

IN­VEST­MENTS

The rental condo brings in gross rent of $2,400 per month. Af­ter pay­ing the mort­gage, prop­erty tax, condo fees, in­sur­ance, clean­ing and so on, they are left with a mea­gre 2.66 per cent re­turn on their eq­uity. Pur­chased for $277,000, 15 years ago, it has ap­pre­ci­ated to $819,000, but it is un­likely that that ap­pre­ci­a­tion can con­tinue for­ever, Mo­ran cau­tions.

Were they to sell the rental condo, their use of it for per­sonal hous­ing for four of the 15 years they owned it would be tax-free. One more year is added, so 5/15ths of the gain will be tax-free. They paid $277,000 for the condo, so just two-thirds of the gain will be tax­able.

If the prop­erty is sold for $819,000 less $35,000 sell­ing costs, they would have $784,000. The tax as­sessed would be about $68,000, Mo­ran es­ti­mates. That would be al­most fully off­set by the in­come tax re­duc­tion pro­duced should they con­trib­ute some of the pro­ceeds into their RRSPs.

If they har­vest $784,000 af­ter costs, pay off the $373,357 out­stand­ing mort­gage bal­ance and add $161,000 to their RRSPs to fill their com­bined space, they would have about $249,643 left over. That money can be used to pay down the $753,342 out­stand­ing bal­ance on their home mort­gage, re­duc­ing it to $503,700. That bal­ance, as­sum­ing a four per cent in­ter­est rate and the present pay­ment rate of $3,127 per month, would be paid off in 19.5 years when Steven and Amanda are in their early 60s and close to re­tire­ment.

RE­TIRE­MENT IN­COME

The cou­ple’s RRSPs have a present bal­ance of $371,475.

If they add $161,000 from the condo sale, to­tal $532,475 plus $600 per month and the ac­counts grow by 3 per cent per year af­ter in­fla­tion for 22 years to Steven’s age 65, they will be­come $1,246,750 in 2018 dol­lars. An­nu­itized to pay out all in­come and cap­i­tal in 30 years, the RRSPs would gen­er­ate $63,610 per year. At age 65, each would re­ceive $7,160 from Old Age Se­cu­rity and $13,610 from the Canada Pen­sion Plan at 2018 rates.

Adding up in­come com­po­nents in re­tire­ment, Steven and Amanda would have $63,610 from RRSPs, two $7,160 an­nual OAS ben­e­fits, two $13,610 CPP ben­e­fits for to­tal re­tire­ment in­come at age 65 of $105,150 per year. If el­i­gi­ble in­come flows are split and taxed at a 15 per cent rate, the cou­ple would have $7,450 per month to spend.

The cou­ple’s present ex­penses to­tal $11,222 per month, in­clud­ing those re­lated to rental in­come. If the rental-re­lated costs are taken out, their ex­penses to­tal $9,165. If other ex­penses not likely to ex­ist in re­tire­ment such as sav­ings and child care are elim­i­nated, their ex­penses drop to about $5,900 per month. That would leave a sur­plus of about $1,550 per month for travel and other ex­penses as the need arises.

Their re­tire­ment bud­get would be en­larged if, once their mort­gage is paid and the kids go off to univer­sity, they add sums pre­vi­ously com­mit­ted to debt ser­vice to TFSAs, Mo­ran notes. If the cou­ple down­sizes their home af­ter the kids have fin­ished post-se­condary stud­ies, re­tire­ment sav­ings would grow.

The prob­lem is too much real es­tate in­clud­ing one not very prof­itable rental, Mo­ran says. With sale of that rental unit and in­creased sav­ings as we have in­di­cated, the cou­ple can have a se­cure and ad­e­quately fi­nanced re­tire­ment.

If Amanda works part time, the fam­ily’s abil­ity to fund RRSPs and RESPs would be re­duced. With grow­ing chil­dren and what are likely to be higher costs as the kids grow up, cut­ting in­come many years be­fore re­tire­ment is not wise. When the kids are all in grade school and child­care costs, now $2,300 per month, drop, there would be cash for leisure, Mo­ran says.

Fi­nan­cial Post e-mail an­drew.al­len­tuck@gmail.com for a free Fam­ily Fi­nance anal­y­sis

WORK­ING PAR­ENTS HAVE SOLID AS­SETS $2.97M

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