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Facelift Sacrificing a home for incomes sake
Facelift Sacrificing a home for incomes sake

Sacrificing a home for income's sake Add to ...

In Toronto, a mid-level manager in the construction industry that we'll call Horace is 62. Divorced, he has accumulated wealth in the form of a $400,000 house, an $800,000 cottage and $460,000 of financial assets. His concern is whether he can maintain a pleasant way of life in retirement. He also wants to eliminate his $175,000 line of credit before he retires.

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His wealth ought to make him secure in his retirement, but he will have trouble - only the financial assets will be producing income to supplement his Canada Pension Plan and Old Age Security benefits. Without action to raise income in retirement, his standard of living will decline.

Client situation

The Person:

Torontonian, 62, planning retirement with heavy debts and two houses

The Problem:

Not enough cash flow to sustain spending

The Plan:

Sell the more expensive house, clear debts, invest remainder for income

The Payoff:

Enough money to maintain way of living in retirement

After-tax monthly income:

$5,382

Assets:

City house $400,000; Cottage $800,000; RRSP $300,000; Non-registered acct. $60,000; Business asset $100,000; Total $1,660,000

Monthly disbursements:

House prop. tax $449; Cottage prop. tax $359; Cottage upkeep $420; Utilities & phone $412; Food $400; Dining out $200; Entertainment $50; Clothing $100; Car fuel, repairs $275; Car lease $868; Car and home ins. $178; Tolls $164; Life insurance $132; Charity & gifts $150; Line of credit interest $500; Misc. $425; Savings $300; Total $5,382

Liabilities:

Line of credit $175,000

What our expert says

Facelift asked Caroline Nalbantoglu, a financial planner with PWL Advisors Inc. in Montreal, to work with Horace. "He will have to make a decision to liquidate the house or the cottage," she says.

Horace's way of life, including monthly savings of $300, costs him $64,584 a year. He can receive about $10,000 in annual Canada Pension Plan benefits if he retires at age 64. If he stops working then, he would have to dip into his $360,000 of liquid assets ($100,000 is tied up in a business and not available for several years). He could receive Old Age Security benefits a year later. Currently, those benefits would pay him $6,204 a year for total income of $16,204. That's not enough to maintain his present lifestyle.

Horace has to develop a plan for easing into retirement, Ms. Nalbantoglu says.

He needs to decide which property to declare as his principal residence, the sale of which will be free of capital gains tax. Tax considerations suggest that it is the cottage because with a cost base of $380,000 and a current value of $800,000, it could produce a capital gain of as much as $420,000 - more than his city home is worth. If Horace clears $700,000 after costs and, allowing for some price reduction in the present market, he can pay off his $175,000 line of credit and still have $525,000 to add to his financial assets. He will save $6,000 a year in interest on the line of credit. He will also save $4,308 a year in property taxes on the cottage and $5,040 in cottage upkeep. These moves will save him a total of $15,348, lowering his annual cost of living to $49,236.

At age 65, Horace can begin to draw Old Age Security benefits. Assuming that he can get a 6-per-cent return from investing the $525,000 proceeds of the cottage sale after paying off the line of credit, plus 6 per cent on $60,000 in a non-registered account, he will have $35,100 in annual investment income. He can add that to an estimated $10,415 from CPP and a $6,204 from OAS for a pretax total of $51,719 a year. After tax, his income will be about $38,670, Ms. Nalbantoglu estimates. He will be short $10,566 to pay for his annual cost of living in retirement. here He can make up that sum by drawing down his non-registered capital, she says.

Horace's RRSPs will continue to grow on a tax-deferred basis. He will have to convert the RRSPs to RRIFs by age 71 and begin withdrawals at age 72. His RRIF income in that year will be $37,000. His estimated total income in that year will rise to $88,719, the planner estimates. His after-tax income will have risen to an estimated $64,200, allowing him to cover his cost of living with no further incursions on his capital.

Maintaining retirement income is a challenge because many assets, including stocks and income trusts, may cut their distributions. Horace elected over many years to put most of his money into stocks and stock mutual funds rather than to buy bonds, bond mutual funds or bond exchange-traded funds. A rule of thumb is that one should have a ratio of bonds to stocks equal to age. Thus Horace should have about 60 per cent of his portfolio in bonds, Ms. Nalbantoglu notes. With little bond exposure now, he needs to make a major switch in his portfolio, she says.

The best time to swap stocks for bonds is in boom times when stocks have high valuations and bonds have relatively low prices. Today, with stock prices low and bond prices high, it is not the best time to make a switch. However, it could be done over time, perhaps as stocks recover. He should consult an investment adviser, she recommends.

Currently, many investment-grade corporate bonds can be had with yields to maturity in a range of 6 to 7 per cent. As well, if a company goes bankrupt, the bondholders rank ahead of shareholders in receiving the proceeds of liquidation. There is a cost to that security for bond interest is taxed as income at full rates, while stock dividends receive a dividend tax credit of as much as 29.7 per cent. But for the retired investor, bonds have a special saving grace, the planner adds.

"A bond has a merit that no stock has," Ms. Nalbantoglu says. "When bonds mature, they pay back their principal to the investor. Stocks don't do that. Sometimes, security is worth paying for," she adds.

"I know that the cottage will have to go, but I may wait a few years to sell it," Horace says.

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