Matthew Sherwood/The Globe and Mail
Gabe and Gwen dream of leaving their Toronto Beaches home in a couple of years for the pastoral charm, rolling vineyards and white sand beaches of Ontario's Prince Edward County.
He is 57, she is 61. Together, they earn about $158,000 a year before taxes.
When they retire, Gabe will get a defined benefit pension from his employer of about $31,000 a year. Gwen, who is self-employed, has no pension plan.
Their plan is to buy a recreational property, financing it by borrowing from their registered retirement savings plan. The RRSP would hold the mortgage. Ideally, they will rent the second property out when they are not using it to help cover costs.
"Since we also may want to retire there, we can use the property as a base to explore the area when it is not rented out and possibly move in when we retire, either selling our house in the city or renting it out," Gabe writes in an e-mail. The Toronto home is valued at $1-million. Their target price for the second home is $350,000.
With retirement nearing, they have a number of questions. Can they afford to retire and buy a second property? Will it be a sound investment? Does it make sense to have their RRSP hold their mortgage rather than borrowing from a bank?
We asked Warren MacKenzie, founder of Weigh House Investor Services in Toronto, to look at Gwen and Gabe's situation. Weigh House is an independent financial planning firm that does not sell investment products.
What the expert says
Yes, Gabe and Gwen can retire in two years and maintain their current lifestyle, Mr. MacKenzie says. They are spending roughly $45,000 a year, excluding savings. The planner's forecast also includes mortgage payments on the new property and assumes they earn a rate of return on their investments of inflation plus 2.5 percentage points.
"They will not be leaving a large estate, but that's okay because that is not their objective," the planner adds. The couple have three children in their 20s. They can afford the recreational property, but they will have to borrow to finance it. They should plan to sell their Beaches home and downsize to a smaller home by the time they retire.
In the first year of retirement, their living expenses are expected to be $70,000 a year and they will pay about $5,500 in income tax. The source of their cash flow will break down as follows: $31,000 from Gabe's pension; $20,000 from their RRSPs (Gwen especially would be in a low tax bracket because she has no pension income); and $24,500 from their other savings.
Later, when they are both collecting Canada Pension Plan and Old Age Security benefits – and making mandatory minimum withdrawals from their RRSPs/RRIFs (age 72) – they will have enough to meet their spending goal without having to draw on their other savings, Mr. MacKenzie says. If they still have two properties, they should plan to sell one at some point. This will give them enough to live comfortably to age 100.
There are pros and cons of buying a second property as an investment, Mr. MacKenzie says. If they can rent it out enough to cover expenses and its value increases in line with inflation, the capital gain on its eventual sale will be taxed at a lower rate than other types of income, which is a plus. On the negative side, they already have roughly half of their net worth in real estate.
"It is not a liquid investment and will require financing," the planner notes. A well-diversified stock portfolio, in contrast, would give them better diversification, liquidity "and probably a slightly higher return," he says. The recreational property "should be considered a lifestyle choice, not a real investment," he says.
"Given they feel they would enjoy their retirement more by having a recreational property, I would say they should buy it even if some other investment might earn more."
He is not so keen on Gabe and Gwen's plan to invest their RRSP money in their mortgage.
"The idea of making mortgage payments to your own RRSP is always appealing," he acknowledges. But having your mortgage in your RRSP makes it impossible to cash in your savings in an emergency.
"If there is an illness or a job loss, or if money is needed for any purpose – including taking early RRSP withdrawals – the house may have to be sold to get the money." The couple may want to invest in easily traded mortgage funds as an alternative.
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Client situation
The people
Gabe, 57, and Gwen, 61.
The problem
Figuring out if they can afford to buy a recreational property and if so, whether it makes sense to finance it by holding the mortgage in their RRSP.
The plan
Go ahead and buy the recreational property.
The payoff
The pleasure of having a country residence that they can either rent or move into at some point, and the flexibility of being able to cash in all or part of their RRSPs in an emergency.
Monthly net income
$8,335
Assets
Bank deposits $40,000; his TFSA $31,000; her TFSA $20,000; his RRSP $118,000; her spousal RRSP $305,000; present value of his pension plan $500,000; children's RESP $48,000; principal residence $1-million. Total: $2.06-million
Monthly disbursements
Property tax $500; maintenance $225; home insurance $100; utilities $350; transportation $620; groceries, clothing $425; charitable $100; vacation, travel $400; personal discretionary (dining, entertainment, clubs, hobbies, pets) $635; life, disability, dental insurance $120; drugstore $50; telecom, TV, Internet $135; RRSPs $700; TFSAs $500; pension plan contributions $950; professional association $115. Total: $5,925
Liabilities
None
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Some details may be changed to protect the privacy of the persons profiled.
Editor's note: An earlier version of this story incorrectly stated the planner's forecast does not include mortgage payments on the new property. As shown above, under "What the expert says," the planner's forecast does include these mortgage payments.