Part of their dilemma is 68-year-old Duke’s refusal to invest in anything but GICs with pathetic yields
Situation: Couple has $3,297,193 net worth, including a leveraged investment in a money-losing condo
Solution: Keep the condo, invest $814,000 of cash and rebalance portfolio, sustain long-term income
In Ontario, a couple we’ll call Duke, 68, and Suzy, 50, are concerned that their present income, $7,869 per month after income tax, will not be sufficient to see them through a retirement that could last many decades.
Their dilemma has two parts: the age gap between them and respective investment attitudes that are night and day, since Duke refuses to invest in anything but guaranteed investment certificates with pathetic yields, while Suzy prefers stocks and bonds and the risks that go with them. Over a period of a few decades, his real income will shrivel while Suzy’s may well pace or beat inflation.
There are other complications: first, Duke insists on keeping $864,000 in cash earning next to nothing in the bank and, second, the interest costs on their condo’s $480,000 mortgage will make the deal flow red ink for years.
“Should we keep the condo?” Suzy wonders.
Family Finance asked Eliott Einarson, who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with the couple.
“The couple’s 18-year age difference is a planning problem,” he noted.
Keep the rental or sell it?
Suzy would like to retire this year, but wonders if that will work in financial terms. The couple view the condo’s projected ownership costs at $2,363 per month — $2,000 for a mortgage and $363 for taxes and other costs — which is more than the estimated $2,000 rent.
The loss could be seen as part of the investment expense for the $600,000 property. But it would be better to use $480,000 of their $864,000 in cash to pay off the mortgage — ignoring any penalties, since they would be negligible as a fraction of the total cost — and buy the condo outright, which would give them a base for a positive return.
Moreover, Suzy thinks they might sell their house one day and move into the condo. That would liberate the $1.3-million value of their house, with perhaps a few costs for primping and an agent.
In retirement, Duke and Suzy estimate they will need $5,500 per month after tax. They spend $4,000 per month now after removing savings and the rental mortgage. They plan to live as well as they do now.
At present, Suzy has $677,402 in registered retirement savings plans (RRSPs) plus $284,480 in non-registered investments and $91,310 in a tax-free savings account (TFSA). Duke has $290,000 in his RRSP, $455,000 in non-registered investments and $69,000 in a TFSA. They have a credit in the form of their $120,000 down payment and a liability to pay $480,000 on the mortgage of the condo they intend to rent.
They also have $864,000 in cash earning perhaps one per cent — or $8,640 per year — in a chartered bank. If invested in stocks or perhaps balanced funds or exchange-traded funds at three per cent for 45 years, that cash could generate $34,200 per year. For now, they accept a pre-tax return on their cash rather than accept the risk of paper losses in periods of volatility.
Their TFSAs, with a present total balance of $160,310, without further contributions and growing at three per cent per year over inflation through equity investments — Suzy’s choice — could pay $6,350 per year for 45 years until Suzy is 95. We’ll cut the proceeds in half so that each partner receives $3,175 per year.
Duke’s $290,000 all-cash RRSP can generate $12,310 per year, or $1,025 per month, annuitized for 27 years until he is 95, assuming a rate of return of one per cent in GICs. His non-registered account with a $455,000 balance can pay out $19,312 annual income, or $1,610 per month, with the same assumption.
He currently receives $894 per month from the Canada Pension Plan and $483 per month from Old Age Security, since he started to draw benefits at age 62, and another $1,145 per month from a former employer’s pension plan.
The sum of these monthly components, $5,157, minus an average tax of 17 per cent, plus $265 per month from his TFSA would be $4,545 per month, or $54,540 per year.
Suzy is willing to take risks in a balanced portfolio with an 80/20 stock/bond blend. Assuming a three-per-cent return for this portfolio of registered and non-registered investments, she can expect her present $677,400 RRSP to generate an annuity of $26,823 per year, or $2,235 per month, for 45 years until she is 95, when all income and capital would be paid out.
Her non-registered investment account with a present balance of $284,480 would pay $940 per month, or $11,280 per year. She could add $7,380 per year, or $615 a month, from OAS and an estimated $8,760 per year, or $730 monthly, from CPP after she turns 60. That is a pre-tax total of $54,243 per year, or $4,520 per month. After 15-per-cent average tax on taxable income and adding her share of TFSA cash flow, $265 per month, she would have $4,100 per month to spend.
The rental, if they pay off the 30-year mortgage, would provide $24,000 annual income per year before $7,956 property taxes, operating costs, insurance, etc. Their net would be $16,044. That is a three-per-cent return on what would probably be an appreciating asset over time. If they move into the condo, they could sell their house for a present price of $1.3 million, less five per cent for fees and fussing, to net $1,235,000. The money they get would be invested subject to a decision about whether to hold cash or stocks.
After the first partner’s death, likely Duke’s given the age gap, the survivor will lose one OAS, most of one CPP and some of Duke’s company pension — a 60-per-cent survivor option is customary. The opportunity to split income will also perish.
Suzy could make up for Duke’s low returns by adding his assets to her diversified portfolio. If Suzy should die first, Duke could eventually find himself in dire straits if he converted her assets to cash, which is guaranteed to be eroded by inflation. His solution, which he may find hard to accept, is to accept volatility risk with capital.
Retirement stars: 3 *** out of 5