Situation: Couple has two houses, modest financial assets and no company pensions
Solution: Sell city house, pay debts, buy condo until wife’s retirement, move to the cottage
A couple we’ll call Fred and Felicity, both 60, live in British Columbia. Fred retired a few years ago from a job in publishing. Felicity does seasonal administrative work. She brings home $3,000 per month for nine months of the year and then draws Employment Insurance at $1,900 per month for the other three months.
On paper the couple is wealthy. The roaring B.C. property market values their home at $2 million and their rural cottage at $650,000. That’s 6.4 times their $414,000 total financial assets including cash. There is only one liability — a $150,000 mortgage on the cottage. Their net worth is thus $2.9 million. But their incomes are modest and they face a retirement that, they fear, will be pinched. The solution: turn some of their pricey property into cash. But which property should go?
Family Finance asked Eliott Einarson, a financial planner in the Winnipeg office of Ottawa-based fund manager Exponent Investment Management, to develop a strategy for unlocking their property wealth.
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“We would like to know if we have enough income to live within our budget without Fred having to go back to work,” Felicity explains.
Fred and Felicity have present monthly expenses of $7,260. Felicity generates a total of $32,700 per year including her three months of annual employment insurance. After 13 per cent average tax, she gets to keep $28,450 per year or $2,370 per month.
Fred will start his CPP soon at a 36 per cent discount from the $858 monthly age 65 benefit to which he is entitled. That will leave him with $550 per month or $6,600 per year.
Converting property to income
Their financial assets, $394,000 in RRSPs, $10,000 in TFSAs and $10,000 in a bank account, are insufficient to support retirement before they draw Canada Pension Plan and Old Age Security benefits. They could keep their two homes and start drawing down their RRSPs. The total, $394,000, if spent over the next 35 years to their age 95, would generate $17,800 a year. Even with Felicity’s essentially temporary income, $32,000 per year and early application by both for CPP benefits, they would be far from the $87,120 per year after tax income they need just to maintain their present way of life. They have two other alternatives:
First alternative: Sell the house soon for $1.9 million after costs (there would be no capital gains tax on sale of a principal residence) and get other accommodation in the city. Then pay off the $150,000 cottage mortgage. They could buy a $750,000 condo to be close to Felicity’s place of work. Or they could keep the $750,000 and rent rather than own. With $750,000 set aside, they would have $1 million left.
Rental is dubious. On $750,000, the price of the condo, they would earn three per cent after inflation, pay 20 per cent average tax and have $1,500 per month for rent — not much for where they live. However, the condo, if bought, would be sold five years later when Felicity retires. That’s a lot of moving and expense, but it would work in financial terms.
The $1 million reserve combined with the $404,000 already in RRSPs and TFSAs (we’re leaving the $10,000 cash for living expenses) would give them $1,404,000 for investment. If this sum is invested to generate a six per cent return less three per cent inflation for the 30 years from ages 65 to 95, it would yield $65,340 per year. Felicity would still be generating $32,700 per year from her work. With his early start CPP of $6,600 per year, the couple’s pre-age 65 gross income would be $104,640. After splits of eligible income and 15 per cent average income tax, they would have $7,412 per month to spend. Their cottage mortgage would be history, so their adjusted monthly expenses would decline to $6,310. They would have a surplus for travel or other pleasures. Sale of the principal house and later the condo would leave them with the $650,000 cottage, no debts and financial assets of $1.4 million.
Second alternative: Sell the cottage for $617,500 after 5 per cent costs, pay off the $150,000 mortgage, and invest the difference, $467,500 for 35 years to exhaust all income and capital for a yield of $21,123 per year. Added to other income sources including Felicity’s essentially temporary $32,700 salary and EI and $17,800 from the RRSP paid out for 35 years and Fred’s $6,600 CPP at 60, would give a total of $78,223 before tax. Split and taxed at an average rate of 15 per cent, they would have $5,540 to spend per month. That’s not enough to support current spending minus $950 per month for the cottage mortgage, net $6,310 per month. This plan won’t work, Einarson says. They should therefore sell the house and keep the cottage.
Retirement cash flow
When Felicity retires at age 65, the picture would change after sale of the condo. They would lose her $32,700 pre-tax job and EI income but gain her estimated $10,272 CPP benefit. They would no longer need the condo near her former place of work. Assuming price appreciation covers selling costs, they could add $750,000 to their capital. Annuitized to pay three per cent after inflation for 30 years, it would generate $38,260 per year. They could add two Old Age Security benefits of about $7,220 per year. Their permanent pre-tax income would then be $128,312. After splits of eligible income and 18 per cent average tax, they would have $8,770 per month to spend with expenses ex-mortgage reduced to $6,310 or less.
They have three cars. In retirement, one car and one home would cut the $965 monthly insurance bill by perhaps $600 per month. Sale of two of their three cars and elimination of one utility bill would trim perhaps $200 from the $455 monthly utility bill.
Assuming they sell their house, their overweight position with 80 per cent of net worth in property would have declined by perhaps a quarter. If they yearn to be back more fully in property, they could invest in real estate investment trusts diversified across cities and sectors. After age 95, they would still have OAS and CPP and their cottage, Einarson concludes.