Eleanor lives in a nice neighbourhood in Toronto in a heritage home that is a gold mine of equity.
Yet that wealth is out of reach for the 67-year-old, single retiree, and she now wonders whether she should sell it to capitalize on its $750,000 of equity.
“I get a lot of pressure from people who are looking at me and saying, ‘I have a lot of capital invested in the house,’” she says.
Yet the prospects of moving are not all that appealing, she adds.
“If I do move and rent, will I end up living in a basement apartment because I won’t have enough income to pay for something nice?” she says, adding she would also lose income from renters.
The $1,400 a month she receives from two renters is her largest source of regular income.
Eleanor says she would ideally live in a nice character condominium or apartment in the same neighbourhood, which wouldn’t come cheaply.
Then she faces the problem of how to invest the proceeds.
Already, she is concerned about the investments held in her RRSP, a portfolio of mostly mutual funds worth about $120,000.
With a net monthly income of about $2,900, Eleanor says she’d like more money to enjoy life, yet she worries about drawing on her RRSP early. She also is concerned the additional taxable income will reduce her government benefits – such as the Ontario Trillium Benefit. Yet she also knows leaving her registered account intact could lead to a higher income later on when she must make mandatory RRIF withdrawals.
“There are a lot of unknowns,” she says, adding she is considering a reverse home mortgage, too. “I’d really like some experts to do some number crunching for me.”
Two financial experts have weighed in on Eleanor’s situation. Cynthia Kett is a fee-only adviser, certified financial planner and accountant with Stewart and Kett Financial Advisers in Toronto, and Daryl Diamond is the author of Your Retirement Income Blueprint and a certified financial planner in Winnipeg.
– RRSP: $120,504 invested in equity and fixed income mutual funds
– High interest savings: $23,800
– TFSA: $26,100, half in a savings account, half in mutual fund
– House: $750,000 (Provides $16,440 in annual income)
Ms. Kett’s tips
1. Eleanor is holding too much cash in her portfolio. “While she likes the security that it provides, she is holding almost a year’s worth of annual expenditures in accounts that do not even keep pace with inflation,” Ms. Kett says. In case of emergency, she could start a home equity line of credit that would provide her with funds if she needs it. “That would enable her to, at the very least, consider purchasing GICs with the cash, if she’s able to find one that pays a higher rate of interest than she is earning now,” she says. “In addition, her TFSA could be invested in something that perhaps has a little higher risk with potential for a higher rate of return.”
2. Eleanor needs to consider management costs on her RRSP portfolio. The mutual funds have management expense ratios (MERs) ranging from a low of 1.37 per cent on the TD Bond fund to 2.5 per cent on the Dynamic Global Dividend fund. The average management cost on the portfolio is about 2 per cent of her assets by year with about $1,000 of her capital going to fund management and $1,400 to her adviser, Ms. Kett says. “Does Eleanor feel that she is receiving the planning and investment advice she needs for the fees she is paying?” she says. “I’m not saying she doesn’t, but she should be aware she is paying for the advice, so she should ensure that she’s receiving value.”
3. Her portfolio, while adequate, could be better. The Dynamic Global Dividend fund provides good diversification, but it is the most costly fund she owns in terms of management costs. The TD Bond fund provides a stable foundation for her portfolio, but leaves more than a quarter of her portfolio exposed to interest rate risk. “Eleanor should be aware that when interest rates rise, the value of the TD Bond fund will fall,” she says. As alternatives, she may want to look at fixed income investments that aren’t affected as directly by interest rates, such as GICs.
Mr. Diamond’s tips
1. Eleanor should draw down her RRSPs sooner rather than later to save taxes over the long term.
She could transfer about $40,000 of her RRSP into a RRIF right away to provide an annual income of at least $2,000, with the option to withdraw more if needed. By doing so, Eleanor would also qualify for federal and provincial pension income amounts, and she would have some additional cash flow with little consequence to her tax situation and income tested benefits, Mr. Diamond says. “She would pay a little more tax and lose a bit of the Trillium Benefit, but those would be more than offset by the extra funds.” More importantly, drawing down her registered investments slowly over the next few years would also help reduce the overall size of the portfolio, reducing her future tax liability. In contrast, if Eleanor left the registered portfolio untouched until she had to make mandatory withdrawals at 72, she would have no choice but to make fully taxable withdrawals of about $9,000 a year, increasing every year afterward. The result would be that Eleanor would end up paying more taxes on her assets while decreasing income-tested government benefits she receives, Mr. Diamond says.
2. Holding savings in a TFSA is an ineffective investment strategy for her.
“Current interest rates are so low, there is no opportunity for capital growth in a savings account, so essentially there is very little prospect to gain from the ‘tax-free’ aspect,” Mr. Diamond says. While she holds one mutual fund in the TFSA, she should consider the following strategy: buying a conservative income fund that pays a monthly distribution. “This would be a very effective way to create a little more cash flow that would not create extra taxation or loss of income-tested government benefits for her.” The income payment will not amount to much additional cash at first, but if she can make systematic, lightly taxed withdrawals from her RRIF and invest the money she doesn’t need in an income fund held inside the TFSA, she can hike tax-free cash flow over time.
3. Eleanor should stay put in her home for now.
“To downsize and sell her home to buy a condo may not free up as much capital as she expects, because condo living can be very expensive,” he says. “The monthly condo fees can be exorbitant – with no cap on those guaranteed.” Renting an apartment matching her current residence’s quality would also be very costly, and she would no longer have income from renters. Still, Eleanor does have a lot of capital tied up in her home. To access some of that wealth, she might consider an all-in-one mortgage, a sort of bank account and a home equity line of credit rolled into one. This type of product would allow Eleanor to borrow up to 50 per cent of the value of her home, the same as a reverse home mortgage. Except an all-in-one mortgage is more flexible and generally bears a lower interest rate than a reverse home mortgage, which can also have expensive setup costs, restrictive limits and unexpected penalties.
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