Situation: Couple has serious health issues and too much of total wealth riding on real estate
Solution: Use some savings to reduce mortgage exposure, keep adding to RRSPs and RESPs
A couple we’ll call Oscar, who is 37, and Mary, who is 43, make their home in Ontario with two children ages 11 and 13. Mary worked until the spring of 2017, then went on long-term disability after treatment for cancer. She now receives net disability payments of $5,771 per month, which is a good deal less than her former salary of about $12,083 per month. Oscar, also disabled, is unemployed. Adding income from a pair of rental properties, and the couple brings in $8,436 per month after tax.
They currently have $400,000 in equity in their home, and another $430,000 in two rental properties. Altogether those properties are carrying approximately $793,000 in mortgages. They plan to move to a new house with an $875,000 price tag for which they will use equity in their present house, GICs and other financial assets for a down payment.
Email for a free Family Finance analysis
Oscar and Mary are committed to real-estate investing. They have done well with it through Mary’s extended illness and Oscar’s unemployment, but they are at significant risk. They have a 4-to-1 ratio of property to other assets. If they can have $5,000 per month in retirement, they can maintain their standard of living. But the risks they are taking to create their income — a huge commitment to real estate — are high.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Oscar and Mary to find ways to reduce portfolio risk in what may be a permanent retirement.
“This file is about very bright people with a lot of real estate,” Moran says. “We can clarify the consequences of that high allocation.”
Saving for family goals
Oscar and Mary have $40,000 in a Registered Education Savings Plan for their two children. They should increase present contributions of $88 per month for each child to $208 per child, for a total of $416 per month or about $5,000 per year. That will qualify them for two $500 Canada Education Savings Grants. Cash for contributions can come from $101,000 cash that the couple keeps for emergencies and potential investments. If the RESP grows at three per cent per year after inflation, it will become about $80,000 and provide the kids with $40,000 each for university. That would cover four years of courses and books and be sufficient if they live at home, Moran explains.
The couple has three properties — their $525,000 home which Mary owns and two $550,000 rentals that Oscar owns. The rentals generate $39,492 annually, about 4.5 per cent on their equity, before income tax and $2,665 per month after tax. They have bought a fourth property, an $870,000 house.
Rather than making the existing home a rental, it would be better to sell it, Moran advises. After five per cent selling costs and primping, they would net about $500,000. Such a sale would allow them to pay off the existing $257,000 mortgage, with $243,000 left over. They could add $502,000 of GICs, total $745,000, and have a mortgage of $125,000 on their new property. With the $2,000 per month payment that they are able and willing to make on the new house, they would be mortgage-free before Mary is 50, and their expenditures would drop by $2,000 per month.
If they make their current home a rental, Oscar and Mary should take appropriate business cost deductions. That would raise cash retention and increase the return on owner’s equity, Moran adds.
Tax management
Several years ago, Oscar had a serious illness that left him with a disability. As a result, he qualified for a Registered Disability Savings Plan. He adds $1,500 per year and the government adds $3,500 per year to the $70,000 balance. The matching grant is available for another 12 years to his age 49. Then it can grow for 10 more years and he can spend it from age 60 onwards.
If Oscar continues to contribute to the RDSP and receives his matching contributions with the money growing at three per cent per year after inflation, it will become $170,765 at his age 49. The matching will be over, but if he continues to add $1,500 per year, the account will grow to $246,690 in 2019 dollars by his age 59. Then, starting at age 60, he would be able to take $12,590 per year for the following years to his age 90.
Retirement income
Neither will receive a full Canada Pension Plan benefit. We’ll estimate 80 per cent of the maximum $13,855 present benefit for each with payments starting at age 65. Each should receive full Old Age Security benefits of $7,360 at 65.
The couple’s RRSPs have a total value of $225,000. If Mary adds $6,000 per year to her RRSP account to fill space and it grows for the next 22 years at 3 per cent after inflation, then at her age 65 it would have a value of $748,470. That sum if spent to exhaust all capital and income for the next 30 years would support payouts of $38,190 per year.
Adding up retirement incomes and assuming that they sell their present home for cash to reduce the cost of buying the new one, then, when Mary is 65 they would have two rents which total $39,492 per year, RRSP income of $38,190 per year, one RDSP benefit of $12,590 per year, one CPP benefit of $11,084 per year and one OAS benefit of $7,360 per year for total income of $108,716 per year. With splits of eligible income and after 19 per cent average tax, they would have $7,340 per month to spend. That’s slightly below their current budget.
Once Oscar is 65, their income would rise. They would gain one OAS benefit of $7,360 and one more CPP benefit of $11,084 for total income of $127,160. With splits of eligible income and 20 per cent average tax, they would have $8,475 per month to spend, about present take-home income.
With reduced expenditures in retirement, Oscar and Mary should have more than enough to make ends meet. A relatively large percentage of their income will still depend on their rental properties, though, so they are susceptible to changes in the rental market.
“A big allocation to rentals has been their salvation,” Moran says. “It is also their risk.”
Retirement Stars: 3 *** out of 5
Financial Post
E-mail for a free Family Finance analysis.