Jasper has a stay-at-home spouse, a house with a mortgage and an income property in downtown Toronto. He is 53, his wife, Jade, 49. They have two children, 18 and 20.
Jasper earns about $130,000 a year as a consultant, while Jade brings in about $3,000 a year working part-time. In addition, they have about $25,000 a year (after expenses but before tax) in rental income. Neither has a company pension plan, but they do have substantial investments.
Jasper wants to retire in five years, sell the family home in suburban Toronto and move to cottage country, where he would work part time. In the meantime, he aims to pay down their debts and perhaps convert a couple of apartments from one to two-bedrooms to bring in more rental income.
“We have solid net worth but lots of debt and less-than-secure income,” Jasper writes in an e-mail. “Can I retire in five years?” he asks. “Could I buy another, smaller income property [once the house is sold] as well as the home in cottage country?”
We asked Warren MacKenzie, founder of Weigh House Investor Services Ltd. in Toronto, a fee-only financial planning firm, to look at Jasper and Jade’s situation.
What the expert says
Jasper and Jade have a net worth of about $1.9-million, with slightly more than 70 per cent of their total assets in real estate. Adding to their real estate holdings would pose some risk, Mr. MacKenzie says. “The danger of this strategy is that 90 per cent of their non-RRSP (registered retirement savings plan) capital would be tied up in real estate,” he notes. As well, they would have to begin withdrawing funds from their RRSPs as soon as they retired to cover their expenses. The couple want to leave their downtown rental property to their two children.
“If there was a real estate decline like the one that occurred from 1989 to 1996, when house prices dropped by 25 per cent [on average] and they had to refinance a property after they retired, they might be forced to sell at a distressed rate,” the planner says.
On paper, their strategy looks alluring because the net cash flow from the investment property is 1 per cent a year on their $1.2-million investment – after paying $69,600 in mortgage payments. In 11 years, after the mortgage is paid off, the cash return is expected to be more than 5 per cent a year.
“In addition, they expect that the property will increase in value at least by the rate of inflation.”
Jade and Jasper need to have a serious discussion about what is most important to them.
“If the most important goal is to leave a large estate to their children, there is an easier way to do it.”
For example, they could buy a whole life, tax-exempt insurance policy that would guarantee payment when they die of the face value to their children.
“With this type of policy, there would be the opportunity to borrow from the increasing cash surrender value if things were to go wrong and they needed money.”
Jasper has no critical illness or disability insurance. If he were to fall ill, he could not only lose his consulting income, but he might also be unable to manage the rental property. To “cover off this risk,” Jasper should look into the cost of such insurance, the planner says. Another alternative to a second rental property would be to put the money into a well-diversified investment portfolio, Mr. MacKenzie says.
“If they did this, they would still have more than 50 per cent of their assets in real estate, but at least they would have liquidity.” Not only would this give them enough money to maintain their lifestyle, it would lower the probability that they would “lose so much that they would be forced to live with their children in their old age,” he adds.
If they really wanted to invest using borrowed money, they could lever up their investment portfolio.
“Using leverage is always high risk, but at least if they were using it to buy stocks, they would have almost instant liquidity and they would avoid the bigger risk of having all of their eggs in the illiquid real estate basket.”
To enhance their estate, Jasper would be well advised to manage the couple’s savings more conservatively, the planner says.
“Currently, he is heavily weighted in small-cap and speculative investments.” Although Jasper believes he has beaten the index, he does not know what rate of return he has earned over the past three years.
“His strategy is to sell losers when they have lost 20 per cent and sell winners when they have broken down technically on the charts,” Mr. MacKenzie says. “He’s had some spectacular success and some spectacular losses, but overall the portfolio is higher-risk than necessary to achieve their goals.”
Jasper, 53, Jade, 49, and their two children.
Figuring out whether their investment and retirement strategy makes sense.
Consider diversifying by buying quality stocks or a life insurance policy rather than another income property. Cut risk in their existing portfolio.
The financial security that well-diversified holdings brings.
Monthly net income
His RRSP $427,000; her RRSP $163,000; stocks $225,000; RESP $40,000; residence $1,000,000; investment property $1,200,000. Total: $3,055,000
Mortgage $3,035; property tax $450; other housing $740; transportation $1,000; grocery store $500; clothing $120; gifts, charitable $100; vacation, travel $500; dining out, entertainment, drinks $650; grooming $100; pet expenses $130; sports, hobbies, subscriptions $150; dentists $100; drugstore $50; term life insurance $100; cellphones $500; TV, Internet $155; line of credit $500. Total: $8,880
Home mortgage $419,000; rental mortgage $630,000; line of credit $150,000 at 4 per cent. Total: $1,199,000
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