Months after she and Robert bought their dream home and moved in together, Tara got a job offer in a field she felt passionate about. She jumped at the chance even though it meant a 30-per-cent pay cut.
They have been used to living well and now find the lower income constraining.
At the time they bought their Saskatoon home, “we had two very strong incomes and it was easily within our means,” Robert writes in an e-mail. When they bought their new home, they kept their previous residences, a house and a condo.
“We have no children and … were used to leading a generous lifestyle,” Robert says, “vacations twice a year, dining out often ... tickets for sporting events.”
Since then, they have tightened their belts “a bit,” but still spend a fair sum on dining and travelling.
Because Robert has a chronic illness that may shorten his lifespan, he would like to retire from his government job at age 55.
He has a defined benefit pension plan that will pay him $1,800 a month at age 55 if he stays with his employer. Tara, in contrast, loves her job and plans to work at least until she is 65. She has no company pension.
Their question: Should they sell their previous residences, pay off the mortgages and invest the balance? Or should they keep the rentals and wait for their value to increase before selling them?
We asked Ryan Knipfel, a chartered accountant and certified financial planner at RBC Wealth Management in Hamilton, to look at Tara and Robert’s situation.
What the expert says
Robert and Tara are spending $67,000 a year excluding savings and debt repayments, so Robert could retire at age 55 without their having to sell the rentals, the planner says.
Still, they may be better off to sell because the rentals are barely breaking even, leaving them vulnerable to a possible rise in interest rates.
“Based on our analysis and assumptions, they would be better off long term, both from a cash flow and a net worth perspective, to sell the rentals, repay the two mortgage loans and invest the proceeds in a diversified portfolio,” Mr. Knipfel says.
If they sold the rental properties for, say, $440,000 before tax and expenses and paid off the related mortgages, they would be left with a balance of about $200,000.
In his calculations, the planner assumes the couple’s lifestyle spending continues throughout their retirement, indexed to inflation. He allows an additional $35,000 vehicle purchase for each of them every seven years. He assumes a 2.5-per-cent rate of inflation, a life expectancy of 90 years and an average annual rate of return on their investments of 5.35 per cent a year.
A key assumption here is that the real estate grows at the rate of inflation, estimated at 2.5 per cent a year, whereas if they sell they could pay off the mortgages and invest the balance at 5.35 per cent.
When Robert retires at 55, their annual cash inflow before tax will be about $183,000 in future dollars, consisting of Tara’s employment income, Robert’s pension income, and non-registered investment income and withdrawals of capital.
In Tara’s first year of retirement at age 66 (Robert is 72 and rolls his RRSP into a RRIF), their total cash inflow will be $162,100 in future dollars, consisting of investment income $30,000, combined Canada Pension Plan benefits $43,000, combined Old Age Security $26,000, Robert’s pension income $36,100, and Robert’s minimum RRIF (registered retirement income fund) withdrawals of $13,000.
The shortfall of $14,000 would come from their capital.
If Tara and Robert believe their properties are undervalued and are apt to rise in price more than the inflation rate near term, they may wish to hold on to one or both of them for a couple of years.
“Rental properties may be rewarding and potentially provide for a more steady financial return in the short term, but just like a stock, they can keep you up at night,” Mr. Knipfel says. “So can a tenant with a leaky faucet.”
Robert, 44, and Tara, 38
How to adjust to lower income, ensure that Robert will be able to retire at age 55, and decide whether it would be better to hold or sell the two rented properties.
Sell the rentals, pay down debt and cut spending.
Financial security both now and in future.
Monthly net income
$9,350; bequest from relative over three years $500; net rental income $156. Total: $10,006
Home $450,000; rental house $190,000; rental condo $250,000; cash in bank $15,000; his RRSP $60,000; her RRSP $210,000; his TFSA $5,000; her TFSA $10,000; present value of his DB pension plan $280,000. Total: $1.47-million
Home mortgage $1,626; other housing costs (utilities, insurance, taxes) $883; house cleaning $150; home improvements $425; transportation $640; groceries $650; clothing, dry cleaning $575; gifts $200; charitable $75; vacation, travel $700; dining out $500; entertainment $475; sports, hobbies $150; TV, Internet $125; pets $30; his RRSP $216; her RRSP $800; his TFSA $379; her TFSA $416. Total: $9,015 Surplus: $991
Mortgage on principal residence $332,000; rental property mortgages $230,000. Total: $562,000
Special to The Globe and Mail
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