Situation:Woman with good career wants to retire at 55 with a $75,000 in annual income
Solution:Sell unproductive rental unit and keep working until 60 to minimize retirement risks
In a small town in Ontario, a woman we’ll call Harriet, 41, brings home $6,000 a month from a job in data management. Nominal rental income of $1,900 per month before costs makes her monthly take-home pay $7,900.
In addition to her house, Harriet has a handful of assets — a $540,000 rental property, $220,000 in RRSPs, and two cars — and owes about $611,000 on two mortgages and a car loan. A single mom, she has paid most of the cost of raising her son, now in his early 20s, and also helps her parents out. Her focus is on retirement at 55 with a $75,000 after-tax income.
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“Should I sell or keep the rental property?” she asks. “It is not much of a money maker. Would that help my retirement?”
Harriet’s work and way of life is about independence and prudence. She has diversified her investment assets into solid real estate which, including her home, comprises 80 per cent of her total assets. That’s a hefty allocation for one asset class and, even more so, to investments which produce hardly any income. Cutting the property allocation makes sense just for putting some distance between Harriet and the roaring southern Ontario property market. Even more so, given that her investment property has turned out to be a rather poor cash generator, it makes sense to review it in light of her financial goals.
Family Finance asked Owen Winkelmolen, a fee-for-service financial planner who heads PlanEasy.ca in London, Ontario, to work with Harriet.
“She is a great saver and her zeal has put her in a position to have a secure retirement, but she may need to wait to age 60 to quit her job,” Winkelmolen suggests. “There are issues to resolve. She has two mortgages, one on her primary residence and one on her rental property. At present, these mortgages will not be paid off until she is 65.”
The rental property is cash-flow negative at present if we set appropriate reserves for repair and vacancy. When those costs are figured in, the property produces a $1,966 annual cash loss. Even with paydown of principal considered as a return, the result is at best a 1.4 per cent annual income before tax. It is not worth keeping.
It would be possible to use Harriet’s equity in the rental property much more efficiently, Winkelmolen says. If the $540,000 property is sold less the $210,000 mortgage due, net $330,000 and five per cent, $27,000, is sliced off for fees and selling costs, $303,000 would be left.
Of that sum, $63,000 can go to a tax-free savings account with a present balance of $500. She liquidated the previous balance, $42,000, to help pay for her new home. The $240,000 balance from the property sale can be used to pay down her home mortgage with a $378,500 outstanding balance. That would reduce her home mortgage to $138,500. If she maintains the present paydown rate of $1,125 per month, the mortgage would be paid off in 12 years at her age 53.
Harriet has focused on retiring at age 55. She can do it with her present assets and future returns, but she should consider waiting an additional five years, Winkelmolen suggests. Delaying retirement would allow her to save more money, provide five additional years of compounded savings growth and reduce the number of years those savings will have to cover. Finally, if she works another five years, her job’s defined-benefit pension would generate an additional $9,336 per year. It’s worth putting in the time, Winkelmolen says.
Harriet is an earnest saver. She maximizes her RRSPs with a present balance of $220,000, each year with contributions of $8,040. In 19 years at her age 60, the account would have a balance of $587,700. That sum, structured as a term-certain annuity generating three per cent per year after inflation to pay out all its holdings by her age 95, would support taxable payments of $26,550 for 35 years.
Harriet has $63,000 of TFSA space on top of a recent $500 contribution. If the $63,500 TFSA contribution grows at three per cent after inflation with $6,000 annual additions for the next 19 years to her age 60, then it would become $262,048 and support payouts of $11,840 for 35 years to her age 95.
At age 60, therefore, Harriet would have investment income of $26,550 from her RRSP, $11,840 from her TFSA, $24,336 from her job pension, and $7,958 from the Canada Pension Plan. The sum, $70,684, if taxed at an average rate of 20 per cent and no tax on TFSA cash flow, would provide $4,920 monthly income to her age 65. At that time, she would receive taxable Old Age Security benefits of $601 per month, boosting net income from her age 65 to 95 to $5,400 per month after 20 per cent average income tax. She will not attain $75,000 per year or $6,250 per month after tax income, but her income — $4,920 before 65 and $5,400 after 65 will nonetheless cover her costs. By working to 60 and selling the unprofitable rental she will have created a good deal of financial security. Her income will be higher and her cost of living will be much lower.
Harriet will no longer make $1,170 total monthly RRSP and TFSA contributions, will have her $340 per month car loan paid, have no mortgage payments — currently $3,000 per month, and will be able to chop her $800 monthly property tax costs in about half. Those savings add up to $5,310 per month, lowering her cost of living to about $2,590. She will have a good deal of money for discretionary spending, especially travel which she craves. Along the way, as costs have declined, she will have added to funds available to help her aging parents.
“If Harriet unloads the unprofitable rental, uses the cash after costs to pay down her home mortgage and invests the rest as we have suggested, she will have financial security and discretionary income for her retirement,” Winkelmolen concludes. “With five more years work and saving, this plan will help Harriet and her family.”
Retirement stars: Five ***** out of five