Luke and Kim, both 48, want to buy a larger home in Toronto but still be able to retire in 10 years.Galit Rodan/The Globe and Mail
Both 48 years old, Luke and Kim are looking to buy a bigger house, retire relatively early from their well-paying jobs in the tech field, leave an inheritance for their only child, 14, and maintain and perhaps increase their standard of living throughout their postwork years.
They earn a combined $400,000 a year. Although they have substantial investments, mainly in Vanguard exchange-traded funds, neither has a defined-benefit pension.
They have a house in Toronto valued at $1.2-million with a small mortgage.
“We are considering purchasing a more suitable, larger home in the future,” Luke writes in an e-mail. They’re wondering how much they can “reasonably” spend without compromising their ability to retire at 58 or so and enjoy their desired lifestyle.
Ideally, they want to find the right balance among retiring early, spending more and improving their lifestyle and potentially leaving a meaningful estate, Luke writes.
Their retirement spending goal is $120,000 a year after tax, rising with inflation.
We asked Ross McShane, an advice-only certified financial planner in the Ottawa area, to look at Luke and Kim’s situation.
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What the Expert Says
Luke and Kim are to be congratulated on having accumulated significant wealth at this stage of their lives, Mr. McShane says. “Their primary concern is not simply whether they are on track for retirement, but whether they can loosen the purse strings and enjoy a higher standard of living before and during retirement.”
They have about $4-million of investment assets and generate a substantial annual cash-flow surplus because their lifestyle expenses are relatively modest, the planner says.
They could easily afford to spend more now. “Based on the assumptions used, they are projected to leave a significant estate to their daughter.”
They figure they would have to spend $2.3-million for the house they want, a significant upgrade from their current residence.
Mr. McShane’s projections assume that the new home is purchased in 2028 and that their existing residence is sold. “I have included estimated real estate commissions, land-transfer tax and moving costs,” he says. Additional funds may be required to renovate, furnish or otherwise adapt the new home to their preferences.
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A larger property will also carry higher ongoing costs, including property taxes, utilities, insurance, maintenance and repairs. “I have included an additional $18,000 annually for these costs.”
He has also included a $24,000 annual expense contingency because their existing budget does not appear to fully account for occasional large household expenditures and other basic and discretionary expenses.
Private-school costs of $30,000 a year are expected to end in 2030 when their daughter begins university. They have sufficient assets in their registered education savings plan to fund her anticipated postsecondary education costs.
Their projected retirement spending at age 58 consists of after-tax lifestyle spending of $120,000 a year, additional housing costs of $18,000, an annual expense contingency of $24,000 and vehicle-replacement costs every eight years.
Retirement expenses therefore total about $162,000 annually before vehicle-replacement costs, indexed to inflation.
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“Based on these assumptions, purchasing the larger home does not appear to compromise their current lifestyle or long-term retirement objectives,” Mr. McShane says. Even if the entire net amount required for the purchase is funded from their investment portfolio, at age 58 they are projected to have about $7-million of investment assets in nominal dollars, equivalent to $5.7-million in today’s purchasing power, in addition to the value of their home.
The projections also suggest that they have the flexibility to enjoy other experiences, including travel and spending part of each winter in a warmer climate, the planner says.
They are also projected to leave a significant estate, which may create additional tax and estate-planning opportunities to address over time, he adds. The projections assume an average annual investment return of 5 per cent and annual inflation of 2.1 per cent.
They will need to decide how to fund the difference between the purchase price of the new home and the net proceeds from the sale of their existing residence. They could use their investments, arrange a larger mortgage or adopt a combination of the two approaches.
Their existing mortgage rate is 3.8 per cent. However, new financing could cost 4.5 per cent or more.
Funding the purchase from the sale of securities in their $1.9-million nonregistered portfolio would generate about $175,000 of taxable capital gains, the planner says. The amount reported by each spouse would be based on the accounts and the investments sold.
They could begin realizing some of these gains before purchasing the home, Mr. McShane says. “Spreading the dispositions over more than one tax year may help moderate the resulting tax liability.” Any advance sales should, however, be coordinated with the anticipated timing of the purchase and their overall investment strategy, the planner says.
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They also hold approximately $400,000 in their TFSAs. These funds could be withdrawn without tax consequences, with the withdrawn amounts added back to their contribution room at the beginning of the following calendar year. The TFSAs could then be replenished gradually using future cash-flow surpluses or funds transferred from their nonregistered accounts. The trade-off is that they would give up tax-free investment growth until the funds are recontributed.
They are not averse to borrowing part of the required amount.
At a mortgage rate of 4.5 per cent, their nonregistered investments would generally need to earn 6 per cent or more before tax to produce a comparable after-tax result when returns are primarily capital gains.
Another option would be to finance a portion of the purchase and then make substantial annual principal payments using a combination of their cash-flow surpluses and proceeds from the gradual sale of existing investments.
“This approach could spread the realization of capital gains over several tax years rather than concentrating them in the year of purchase,” the planner says. It would also allow a larger portion of the portfolio to remain invested for longer. The potential tax deferral and continued investment growth would have to be weighed against the mortgage interest cost and the risk that investment returns may be lower than anticipated, Mr. McShane says.
Kim has about $400,000 within her corporation. If the corporation has a positive capital dividend account balance, a portion of these funds may potentially be distributed as a tax-free capital dividend, Mr. McShane says.
Their asset allocation is 30 per cent fixed income and 70 per cent stock ETFs. “This balanced-growth allocation is reasonable given their financial position and the fact that they do not expect to rely on their portfolio for retirement income for 10 years.”
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Once they have a clearer estimate of the amount they will contribute toward the purchase, that portion should be gradually moved into a high-interest savings account, cashable GICs or other suitable short-term investments, Mr. McShane says. This will preserve the required capital and reduce the risk of having to sell investments following a market decline.
Cash-flow surpluses remaining after RRSP and TFSA contributions should also go to a high-interest savings account or another suitable short-term investment so the funds will be secure and readily available for the purchase, the planner says.
Client situation
The People: Luke and Kim, both 48, and their daughter, 14.
The Problem: How much can they afford to spend on a new home without jeopardizing their other financial goals?
The Plan: Go ahead and buy the house they have in mind, taking time to weigh the various options for paying for the purchase.
The Payoff: Knowing they can afford to spend more freely now and in future even after buying a more expensive residence.
(Income, expenses, assets and liabilities provided by the applicants.)
Monthly after-tax income: $22,100.
Assets: His nonregistered portfolio $1,225,055; her nonregistered $682,240; his TFSA $204,783; her TFSA $199,654; his RRSP $565,430; her RRSP $499,070; his locked-in retirement account $200,665; her defined-contribution pension $52,235; RESP $112,000; house $1.2-million; her corporate account $423,540. Total: $5.3-million.
Monthly outlays: Mortgage $2,000; property tax $350; water, sewer, garbage $60; home insurance $80; electricity $100; heating $100; maintenance $200; transportation $275; groceries $1,000; private school $2,500; clothing $100; gifts, charity $150; vacation, travel $1,500; dining, drinks, entertainment $600; personal care $100; sports, hobbies $100; subscriptions $50; health care $60; health, dental insurance $200; life, disability insurance $100; communications $100; RRSPs and her DC pension $3,985; TFSAs $1,165; contingencies $2,000. Total outlays: $16,875.
Liabilities: Mortgage $40,000.
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