FAMILY FINANCE
SITUATION
Couple wants to retire but is weighed down by impulsive deal
STRATEGY
Cut price on vacation home and take a loss to free up cash
SOLUTION
Reduced risk, increased cash flow after work ends
A couple we'll call Herb, 66, and Margaret, 55, thought they were buying into a tropical paradise when they plunked down $150,000 for a beachfront property in Indonesia 15 years ago. Instead it turned out to be a financial nightmare, picturesque but remote and hard to rent.
In retrospect, buying a place that took hours of driving from the nearest airport was, as Herb says, "a case of enthusiasm exceeding realism."
With a cost of $3,600 a year for maintenance fees and taxes, it is a white elephant. They are trying to sell it for $100,000 but there hasn't been a decent offer in the three years it has been on the market and it is so remote, renting is impossible. Though the house is only a fraction of their total assets, continued maintenance will be a drain on their income.
"It has to go," Herb says. The question is how much are they willing to cut the price to make a sale.
The couple has about $2-million in assets and a portfolio of mostly large-cap stocks that pay dependable dividends and senior bonds of reputable companies. Herb, a management consultant with an international practice, and Margaret, an officer with a large non-profit organization, bring home a total of $130,000 a year. There are no debts apart from credit card bills, which they pay off immediately.
To get ready for retirement, they plan to sell their $550,000 suburban Toronto condo within a few years and move to somewhere less expensive on the Prairies. "Should we work another few years to add to our reserves or can we retire now?" Herb asks.
Family Finance asked Graeme Egan, a financial planner and portfolio manager at KCM Wealth Management Inc. in Vancouver, to work with the couple.
"Their position is enviable, but they see the problems of harvesting equity from their Toronto house and foreign property as reasons to wait," he says. "My job is to test the two scenarios - retire very soon or wait a few years."
STRATEGIES
If they downsize, sell the foreign property for $100,000, extract $100,000 equity from their Toronto condo and bank the proceeds, they could supplement their non-registered assets, $622,000 in stocks and bonds and $100,000 in a GIC. That would give them $922,000, not including a $40,000 bank balance they would use for the costs of setting up a new home.
If they can get an average of 5% from this portfolio - 3% dividends and 2% capital growth - and if Margaret's pension is transferred to a locked-in retirement account, they would have annual pre-tax non-registered income of $46,100, including Canada Pension Plan benefits of $420 a month that Herb already receives.
His OAS benefits, reduced by the clawback that starts at an annual income of $69,562, total $320 a month. Those benefits total $8,880 a year and make total annual pretax income about $55,000.
In retirement, their expenses, inflating at 2% a year, would be about $6,000. They could pay the $2,000 monthly gap between costs and their $4,812 monthly income by tapping Herb's corporate investments or RRSPs. Either way, they would be running down capital at nearly $20,000 a year, Mr. Egan estimates.
WORKING LONGER
If Herb and Margaret work another three years, they could add $88,000 to their RRSPs. Their non-registered assets could grow by 5% a year to $836,000 and they could add $100,000 from downsizing their home and, ideally, another $100,000 from selling the Indonesian property. The two sales would push non-RRSP investments to $1,036,000. Their RRSPs, Margaret's company pension and their TFSAs would grow to $560,000, plus the $88,000 of continuing contributions, for a total of $648,000, the planner says.
If they choose to exhaust their non-registered capital by Margaret's age 90, they would have $77,000 a year, or $6,417 a month, before tax. Assuming a 20% tax rate, they would have $5,133 to spend each month. They would be short $867 a month, but they could cover the difference out of their cash balances or by tapping investments that are now in Herb's company and that will, after he shuts the business and pays any accrued taxes, be an emergency account.
When Margaret turns 65, she could receive CPP benefits of $6,000 a year and $6,540 OAS, pushing total income to about $89,500 before tax. At that time, Herb will be 71 and will have to start taking $24,000 a year of RRSP benefits through a registered retirement income fund. At this point, the couple's total income would be about $113,500 before tax. After 20% tax, they would have approximately $7,565 a month to spend. They will have covered their estimated future expenses and have a cushion of savings for emergencies, gifts or perhaps good causes, Mr. Egan says.
There remain risks. The largest is the $100,000 tied up in their Indonesian house. It ties up capital that could earn several thousand dollars a year plus the $3,600 annual upkeep cost. Cutting the offering price by 20% to 30% to liberate capital and cut expenses may be wise.
Herb and Margaret can retire soon, but only at the cost of erosion of capital or cutting back expenses, Mr. Egan says.
"Delaying retirement would give them time to sell the foreign house and to downsize their Toronto home. Then they would have a more secure retirement."
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