Albert and Anna are professionals in their mid-30s earning a combined $248,000 a year before tax. They have a toddler and hope to have at least one more child.
They wish they could spend more time with their daughter, "but alas, due to the demands of our professional careers, it is difficult, and we find ourselves living for the weekend, as I'm sure many hard-working, well-meaning parents do," Albert writes in an e-mail.
They're keen travellers and have talked over the years about "how great it would be if we could travel the world indefinitely, with money as no object, no work encumbrances and with children by our side," he adds. The birth of their first child "has inspired us to continue on the path to financial freedom. We want to quit working as quickly as possible," Albert writes. Age 45 would be ideal.
Neither has a company pension, although Anna will be eligible to invest in a company stock purchase plan after she has been in the job one year.
They own three rental properties, as well as their Toronto-area residence, all mortgaged. They also invest in blue-chip stocks that pay a steadily rising stream of dividends. The idea is to have investments that will rise in line with inflation, generate a tax-efficient income stream of $100,000 a year when they retire and that they can leave to their children when they die.
Their question: Should they sell the rentals and shift to purely financial investments? Or should they stick with the real estate and maybe add a Florida property?
We asked Ross McShane, director of financial planning at McLarty & Co. Wealth Management in Ottawa, to look at Anna and Albert's situation.
What the expert says
At this stage of their lives, such a high net worth is unusual, Mr. McShane says. Anna and Albert's lifestyle expenses are about $60,000 a year before child care and excluding debt service charges, he notes. Their retirement income goal of $100,000 a year after tax would allow for significantly more travel and leisure spending.
"Obviously, striving to achieve this income goal with such an early retirement is quite a stretch," the planner says. Based on his calculations, their investment capital and the equity in their rental properties would be depleted by age 80. If they lowered their spending target to $75,000 a year after tax, though, they should be able to achieve their goal, Mr. McShane says.
His calculations assume an average annual rate of return on investments of 5 per cent a year and 2 per cent inflation. The planner further assumes university education costs for their daughter of $20,000 a year for four years.
"If they have more children, their family expenses will increase in many areas," he says. "This will [affect] their retirement goal."
Selling the rental properties and investing the proceeds "is a very big decision," Mr. McShane says. They would face a capital gain of $665,000 on their property portfolio at a time when they are both in a high tax bracket. "There would be a much lower tax hit if the properties are disposed of at retirement."
He recommends they do an analysis of how profitable each property is, as well as an assessment of anticipated major repairs, before they decide whether to hold or sell.
A note of caution: They have more than 70 per cent of their net worth in Toronto real estate, the planner notes. He suggests they diversify their property portfolio, perhaps by selling one of the Toronto rentals and either buying the Florida property they are considering or investing the sale proceeds in their portfolio to provide more liquidity.
Both Anna and Albert have yet to open a tax-free savings account. As well, they have unused room in their registered retirement savings plans. Mr. McShane suggests they focus on the RRSPs first. Albert should contribute enough to his RRSP this year to lower his taxable income to $90,000, but no more. This would involve using all of his carry-forward room and his 2015 room. Anna could contribute $20,000 to her RRSP, which after claiming child-care costs would put her in the desired tax bracket, as well.
"The balance of the cash flow should be used to either pay down the principal residence mortgage or to start investing in their TFSAs."
Anna and Albert have enough of a monthly surplus (after annual RRSP contributions) to pay off the mortgage on their principal residence within seven years. Alternatively, they could open TFSAs and contribute as much as possible. "I would not make the acceleration of the rental property debt a priority because it is tax-deductible," Mr. McShane says.
The people: Albert and Anna, 34, and their daughter, 2
The problem: Can they realize their dream of retiring at age 45 and travelling the world, free from care, with their children? What are the most tax-efficient investments to achieve their goals?
The plan: Lower their retirement spending target, or work longer. Do a proper investment analysis of their real estate properties. Diversify their investment portfolio.
The payoff: Much could change over the next few years if they have more children, but at some point they will achieve their goal of financial freedom.
Monthly net income: $17,445
Assets: His RRSP $120,000; her RRSP $135,000; RESP $10,000; principal residence $750,000; rental properties $1,650,000. Total: $2,665,000
Monthly disbursements: Debt service $5,155; property tax $400; insurance $50; maintenance $400; utilities $285; transportation $850; grocery store $500; clothing $100; life insurance $225; cleaning $100; child care $1,145; telecom, TV, Internet $200; miscellaneous personal $220; entertainment $600; hobbies and activities $200; donations $100; travel $625; miscellaneous $50. Total: $11,205. Surplus available for savings or paying down mortgage: $6,240
Liabilities: Residence mortgage $404,000; investment property mortgages $833,000. Total: $1,237,000
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