Reviews and recommendations are unbiased and products are independently selected. Postmedia may earn an affiliate commission from purchases made through links on this page.
A couple we’ll call Frank, 58, and his wife, Kerry, 54, live in Alberta. They have four children, all married and with families of their own. Frank is an administrator in the provincial government, Kerry a part-time shipping manager. Rental income supplements their salaries.
Frank and Kerry would like to retire within five years and maybe in as soon as a year, and visit perhaps 25 countries in the following 15 years, take five cruises at a cost of $12,000 per cruise over that span, then bunk down in southern B.C. or a warm place in the U.S. To support their plans, they have $1,050,000 in rental properties, the $365,000 equity in their home and Frank’s defined-benefit pension, which will pay him $28,750 per year. Their dreams will stress their resources.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with the couple.
The primary questions — when to retire and how to finance decades of travel — are not easy to solve. Moreover, the couple’s finances are not well diversified. They have $1,290,000 in six rental condos and a home with an estimated value of $700,000 leveraged against mortgages of $240,000 for the rentals and $385,000 for their home. There are no stocks or bonds, mutual funds or exchange-traded funds in their portfolio. They have no TFSAs nor RRSPs. However, they have $215,000 in uninvested cash, much of which they have targeted for paydown of their home mortgage, which has a 20-year amortization and 2.8 per cent interest rate and costs them $2,130 per month.
Their retirement plan is dependent on Frank’s defined-benefit pension, which is a contract rather than his property, and the strength of the real estate markets in small-town Alberta, where they hold their rentals.
Currently, the couple’s income comes from $120,000 in combined pre-tax salary and $50,256 in rental income, for monthly after-tax income of $12,557. After their home and rental mortgages are paid off, their spending will drop to $8,097 per month. That’s $97,164 per year. At 65, tax credits will reduce the gross income needed to meet the net amount, Moran notes. As well, at 65, Frank can draw defined benefits from an unindexed pension of $28,750 per year.
The couple has too much cash sitting idle. $51,000 should go to Frank’s RRSP, bringing his taxable 2022 income down to the top of the first federal bracket. $19,000 can go to Kerry’s RRSP. $62,000 can go to a penalty-free payment on their home mortgage. These allocations will generate refunds of $51,000 + $19,000 or $70,000 times 30.5 per cent. That’s $21,350. That capital, generating three per cent after inflation for the following 35 years to Kerry’s age 90, would support pre-tax cash flow of $965 per year for the couple.
After their mortgage anniversary passes, which will be in fall this year, they can add another $62,000, dropping the outstanding mortgage debt to $385,000 less two times $62,000 or $261,000.
The rentals are profitable. They generate returns on equity of 3.12 per cent to 8.44 per cent and their net cash returns will grow as their mortgages are paid down. Moreover, as mortgages head toward zero due, leverage and risk will decline. But Frank and Kerry will still be betting much of their retirement on one asset class in one town. Diversified they are not.
For now, the property values are only slightly above what they paid. If they sell properties to buy Canadian shares, they will have a tax advantage, for the tax rate on their net rental income is about 30.5 per cent compared to their bracket times half the gain if there is a sale. Capital gains tax would be half that or 15.25 per cent and Canadian dividends would have a 10.16 per cent tax rate. The advantage is to Canadian eligible dividends that benefit from the dividend tax credit. In retirement, tax rates would be lower.
Frank and Kerry can apply for Canada Pension Plan benefits at 65. Frank can expect $13,539, Kerry $7,522, Moran estimates. Each can apply for full OAS, currently, $7,707 per year, at 65. Their RRSPs have zero balances at present, but Frank has $108,190 of room and Kerry has $60,354 of room. Our suggestion is to put $70,000 into their RRSPs. If they retire within a year and spend their balance over the next 35 years to Kerry’s age 90, then, assuming a three per cent return over inflation, they could draw $3,162 of taxable income each year. If they can raise net $1 million and if they obtain four to five per cent from rent or dividends, they would have $47,250 pre-tax income with advantageous tax rates on Canadian source dividend income if they buy Canadian stocks.
From retirement to Frank’s age 65, they would have his $28,750 pension, $3,162 combined RRSP income and assumed rent or dividends if properties are sold of $47,250. That’s a total of $79,162. With splits of eligible income and an average tax rate of 14 per cent, they would have $68,100 per year or $5,675 per month to spend, less than present $6,945 per month with carrying cost of the rentals eliminated.
Studying the market pays off for savvy couple with 12% gains and ‘bulletproof retirement strategy’
Couple in their 40s with $3 million in assets must diversify if they want early retirement
Ontario couple needs to plug a leak in their finances before settling in to a five-star retirement
Once Frank is retired, he can add $13,539 CPP and $7,707 OAS for total income of $100,408. With splits and average tax at 17 per cent, they would have $82,390 per year or $6,945 per month, the same as present spending.
Once Kerry is retired, they can add her $7,707 OAS and $7,522 estimated CPP benefits for total income of $115,637. After 19 per cent average tax, they would have $93,665 to spend or $7,800 per month.
These are conservative calculations built on slim foundations. A crash in Alberta property prices or even failure to realize sale prices of their rentals would require postponement of retirement. If mortgage rates rise a great deal when it’s time to refinance condos, even big boosts in condo fees they pay or failure to rent just one of their six properties would hobble their plans for retirement before Frank is 60. They have hung their retirements on delicate threads.
Retirement stars: 3 *** out of 5
Email firstname.lastname@example.org for a free Family Finance analysis.