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financial facelift

Rafal Gerszak/Globe and Mail

Faith is a recently separated, 53-year-old professional woman who makes about $32,000 a year working in the complementary health-care field.

She has two teenagers, one going into second-year university this fall and the other Grade 12. Since the family house was sold, Faith has been renting for about $3,500 a month. She wonders whether she should continue to do so “or get back into the real estate market – a scary proposition in Vancouver, especially because capital preservation is my No. 1 goal,” she writes in an e-mail.

Either way, she will be relying on her investments to supplement her income, which falls far short of her spending. Fortunately, she has substantial assets, including assets in a corporation – part of her separation agreement – $400,000 of which is available tax-free.

Faith’s questions: “Can I afford to buy a new townhouse? If so, how much can I afford? What should I do with my investable assets? Will the proceeds of my investments cover the gap between my lifestyle expenses and my income?”

We asked Ian Black, a portfolio manager and financial planner at Macdonald Shymko & Co. Ltd. in Vancouver, to look at Faith’s situation. Macdonald Shymko is a fee-only financial planner with an investment counsel arm.

What the expert says

“There are significant changes happening in Faith’s life, which complicates the planning process,” Mr. Black says. Faith is spending about $131,000 a year, far more than her employment income. “She admits she has a pretty high ‘burn rate,’ which will not decline significantly when her children are on their own,” he adds. “In the short-term, this is a significant risk.”

Mr. Black examines three options: One, Faith continues to rent and invests her money in a diversified portfolio of exchange-traded funds, 40-per-cent fixed income and 60-per-cent equity. Two, she buys a new home for $900,000 and lives in it for the rest of her life. Three, she buys a $1.35-million home and then downsizes to a $950,000 home later, investing the balance. “All three options are sustainable through to age 95, but each carries its own tradeoffs of risk and reward.”

Faith has about $3.7-million of investable assets. Mr. Black assumes a return on investments of 4.55 per cent a year (before inflation) and a 4-per-cent annual rise in rent, double the inflation rate.

In option one, Faith spends $131,220 a year after-tax until she retires at 68, when her spending drops modestly to $120,000 a year. “All of her assets, aside from her family cottage, are invested in the assumed 4.55 per cent portfolio, so by age 95 her after-tax, inflation-adjusted estate is estimated at $1.6-million.” She would still have significant financial assets available to protect her from outliving her savings.

In the second option, Faith purchases a home valued at $900,000. Housing costs such as property taxes, condo fees, insurance and maintenance are $1,500 a month, compared with the $3,500 she is spending on rent, so her expenses are lower. Her annual after-tax spending would fall from $131,208 to $107,208. There would be some savings in taxation because a principal residence does not generate taxable income or gains, the planner says.

The value of Faith’s estimated after-tax, inflation-adjusted estate drops to $1.3-million, all in the form of real estate, and her liquid assets are exhausted at the age of 94. “Not ideal, and no room for error.”

The third option has a more flexible mix of real estate and remaining portfolio assets. “She can afford to make a larger initial investment in a home – $1.35-million – because her intention will be to trade down at a future date,” Mr. Black says. She will need less income than if she was renting, while her remaining financial portfolio will allow her some flexibility in choosing the timing of downsizing to a less expensive home. He estimates that she could free up about $1-million at the age of 72 because the home will have risen in value over 20 or so years to nearly $2-million. By the age of 95, Faith will have consumed almost all her assets with the exception of the cottage and her home.

For Faith, “option three probably makes the most sense,” Mr. Black says. His only concern is that $1.35-million might not be enough to buy a place Faith considers suitable. If she spends more, she may have to trade down sooner or try to cut her consumption in order to make her investments last.

The timing and amount of dividends will be important to manage taxable income in order to maintain full Old Age Security benefits, the planner says. He assumes Faith takes about $75,000 a year in dividends for the next 10 years. “Ideally, the corporate assets should be exhausted before OAS begins.” Monitoring her portfolio and her spending habits will be important to ensure she maintains sufficient assets.


Client situation

The person: Faith, 53, and her two children

The problem: Can she afford to get back into the housing market in pricey Vancouver and still have investments sufficient to cover her big cash-flow shortfall?

The plan: Explore the options, and consider buying with a view to downsizing in 20 years or so and investing the balance. Endeavour to exhaust corporate assets before collecting Old Age Security benefits.

The payoff: Financial security without having to sacrifice the style of living to which she has grown accustomed.

Monthly net employment income: $2,840 (child support excluded because it will expire)

Assets: Bank deposits $1,943,640; corporate assets $1.1-million; lump-sum settlement $400,000; registered retirement savings plan $307,620; tax-free savings account $42,125; recreational property $465,000. Total: $4.26-million

Monthly outlays: Rent $3,500; condo fee $70; property tax $115; home insurance $105; utilities, maintenance $300; transportation $615; grocery store $1,000; children’s activities, lessons $1,010; clothing $400; gifts, charity $275; vacation, travel $700; dining, drinks, entertainment $475; personal care $260; club memberships $420; golf $100; pets $475; subscriptions $50; other personal $500; health care $150; health, life insurance $215; phones, TV, internet $200. Total: $10,935 Shortfall comes from dividends, savings and investments.

Liabilities: None

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Some details may be changed to protect the privacy of the persons profiled.