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Getting a handle on spending Add to ...

Jill and Darby, both 62, are looking forward to easing into retirement. She has her own business and he has just quit his job to work as a consultant.

Together, they earn a tidy sum, netting $10,000 a month. But their spending is high, too.

And they are in the real estate market up to their ears.

They have a cottage on Georgian Bay worth about $700,000 with two lines of credit on it, one for a down payment on a couple of rental properties and the other to lend money to their children, who are making regular payments.

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They have a home in Barrie, Ont., valued at $300,000 with a $135,000 mortgage, and the two rental properties that just cover their costs and in which they have virtually no equity after the cost of selling them is taken into account. They plan to sell the income properties one day and divide the anticipated profit with their son and daughter.

As well, they hold $200,000 mortgages for each of their two children, who each pay them $1,200 a month.

Their plan is to retire on about $80,000 a year, far less than the $100,000-plus they are spending now. The $100,000 doesn't include the $2,000 a month credit card payment.

"Can we survive in retirement?" Jill asks in an e-mail.

We asked Gina Macdonald, a financial planner at Macdonald, Shymko & Co. Ltd. in Vancouver, to look at Darby and Jill's situation.

What the expert says

Darby and Jill have more than $1-million in savings and investments, including the mortgage loans to their children, Ms. Macdonald notes. This, plus Canada Pension Plan and Old Age Security payments, is enough to give them an income stream (capital plus income and gains) of $92,000 a year. That assumes a 6-per-cent rate of return on their investments and an inflation rate of 3 per cent.

But will even $92,000 be enough? If Darby and Jill are to live on less, they will need to get a handle on their spending, Ms. Macdonald says. Where does the $2,000 a month in credit card payments go?

Now that Darby, too, is self-employed, she suggests they set aside their cash on hand and guaranteed investment certificates as an emergency fund to see them through the transition.

Next, they can tackle the mortgage on their home, using some of their savings or the loan payments from their children to pay it off as quickly as possible.

"It should be every Canadian's goal to retire with your principal residence mortgage paid off as it could cause a cash flow crunch in retirement, and one becomes very susceptible to interest rate changes," the planner says.

If the loans to their children are not properly documented, they may also be vulnerable on that front, too.

"I would want them to ensure that these mortgages are registered on title and that a mortgage/promissory note document is drawn up where both spouses sign the document." The same goes for the line-of-credit loan.

As well, they need to revisit the interest rate they are charging every few years to make sure their investment returns keep pace with the interest rate environment.

Finally, the rental properties. They are bringing in enough money to cover expenses now, but they are subject to interest rate risk, Ms. Macdonald cautions. Darby and Jill would be well-advised to reduce the leverage on these properties.

Even then, they have too many eggs in one basket.

"People need to watch their real estate diversification with regard to location," the planner notes. Darby and Jill have their home, their cottage and two rental properties all in the same region. Their children also live in the area, raising the couple's exposure to a single real estate market even further because of the mortgages they hold.

"They have 72 per cent of their net assets in real estate in the Barrie/Georgian Bay area - almost $1.8-million," Ms. Macdonald says.

They may want to reconsider their risk profile and their ability to absorb a rise in interest rates in deciding whether holding the two rental properties matches their short- and long-term goals, she says.

Client Situation

The People:

Darby and Jill, both 62

The problem:

How to prepare for retiring in a few years with a fair amount of debt and a fairly high standard of living.

The plan:

Get a handle on spending, set aside a cash reserve now that Darby is self-employed, pay off the home mortgage as quickly as possible and rethink the investment properties.

The payoff:

No need to worry about unexpected expenses once they quit working so they can put up their feet and relax.

Monthly net income:

$10,000; mortgage payments from children $2,400. Total $12,400.

Assets:

Cottage $700,000; family home $300,000; two rental properties $380,000; mortgages to children $400,000; loan to children $75,000; locked in RRSPs $60,000; his defined contribution pension plan $130,000; her RRSP $240,000; TFSAs $7,000; cash in bank $42,000; GIC $9,200; his RRSP $40,000; guaranteed income fund $125,000. Total: $2.5-million.

Monthly disbursements:

Mortgage on home $850; RRSP and TFSA contributions $1,450; utilities $250; taxes $280; food $700; gifts/charity $560; life insurance $550; house insurance $400; health benefits $380; credit card payment $2,000; dog $80; meals out $100; clothing $290; cable $110; telephone $80; home repairs $300; vehicle insurance $170; CAA $25; postage $20; reading $50; recreation/sports $100; cottage (taxes, boats, utilities) $1,200. Total: $9,945.

Liabilities:

Line of credit on cottage (down payment rental properties) $90,000; Line of credit on cottage (loan to children) $75,000; mortgages on rental properties $265,000; mortgage on family home $135,000. Total: $565,000.

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