Eileen and Evan want to use their recent inheritance to benefit their entire family, including their children and grandchildren. The problem is, $100,000 only goes so far.
Evan is 57, Eileen 54. Both have good professional jobs with defined benefit pension plans that will pay them a combined total of about $6,675 a month at age 65. Their children are 29 and 32.
Nothing stimulates the imagination like a windfall, and the couple see a wide array of possibilities opening up before them: Putting an addition on their beloved house in Victoria that could be rented out, or used by aging parents or in future by grandchildren. Paying off their mortgage. Taking advantage of unused contribution room in their registered retirement savings plans. Investing. Buying a second property to rent out. Giving $50,000 to each of their children to help with home purchases.
"How can we best manage our money – and our retirement – to ensure our kids benefit the most from this inheritance?" Eileen writes in an e-mail. She and Evan lean toward adding a one-bedroom unit to their century home because the back of the house needs work anyway and the house is "in a beautiful, walkable neighbourhood with fantastic people," she adds. Being downtown will allow them to sell one of their two cars in the fall "and rely more on our bikes, our feet and public transit." When they retire, they want to travel.
We asked David Barnsdale, a vice-president and investment adviser with RBC Dominion Securities Inc. in Mississauga, to look at Eileen and Evan's situation.
What the expert says
Given their age and income, Eileen and Evan can achieve more than one of their goals, Mr. Barnsdale says. He suggests they contribute the maximum to their RRSPs and TFSAs, then apply the balance to their mortgage. They could then borrow $100,000 to build the rental addition. The interest rate on the loan would be tax deductible and the cash flow from the rental unit would more than cover the payments.
He suggests they top up Evan's RRSP by $10,800 and Eileen's by $12,500 a year for the next several years until her carry-forward room is used up.
The tax refund from the RRSP contribution could be used to pay down their mortgage and/or top up their TFSAs. They have $12,500 each in their TFSAs, so they can contribute an additional $7,500 each this year and $5,000 each for 2013.
Based on the adviser's calculations, Eileen and Evan do not need the rental income from their addition to meet their retirement spending goal of $85,000 a year after tax, but, "It would most definitely enhance their retirement lifestyle and add income that would cover their desire to travel more often," Mr. Barnsdale says. Otherwise, they may have to rein in their goal of taking one big, extended trip every three years as well as Evan's goal of quitting work at age 62 rather than 65.
The adviser's calculations assume a 5.4 per cent rate of return on investments and a 2.5 per cent annual inflation rate.
The home improvements Eileen and Evan plan will not only enhance the value of their house, but could also generate $9,600 a year of rental income, "a very decent return on investment of 9.6 per cent gross before other expenses," Mr. Barnsdale notes. He's not as keen on the alternative of buying a rental unit because the return would not be as high.
At the rate they are paying off their mortgage, Evan and Eileen figure it will be paid in full in about two and a half years. Under Mr. Barnsdale's plan, it would be paid off much sooner.
"Mortgage interest on a personal residence is not tax-deductible, which is why I would suggest paying it off as soon as possible," he says. He suggests they seek advice from their accountant on the tax implications of the rental addition.
Eileen, 54, and Evan, 57, and their family.
How best to spend a $100,000 inheritance to benefit the entire extended family.
Get their own finances in order first, paying down the mortgage and contributing to their RRSPs and TFSAs. Borrow to build the rental unit.
A secure retirement, an apartment that can either bring income or be used by family members, and their house to leave to their family.
Monthly after-tax income
Home $663,000; RRSPs $171,000; TFSAs $25,000; bank savings $83,000; his DB pension (present value) $938,998; her DB pension (present value) $636,494. Total: $2,517,492
Mortgage $2,977; maintenance $1,500; property tax $315; utilities, insurance $386; transportation $585; groceries $875; clothing $200; vacation $500; wine $230; grooming, fitness $110; club memberships $120; entertainment $170; pets $100; subscriptions, hobbies $56; health, life insurance $266; dentist, drugs $30; telecom $86; RRSPs $600; professional associations $110; pension contributions $1,344. Total: $10,890. Surplus: $639
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