Millionaires On Paper

Andrew Allentuck

A couple we’ll call Julia, who is 46, and Jack, who is 59, have a leafy, leisurely life in B.C. They are millionaires on paper, with net worth of $2,449,000. Their incomes, however, are modest. Julia brings home $3,100 per month from her job with the provincial government.

Jack generates $3,200 per month after expenses from renting out a small apartment building he and Julia own and doing part-time maintenance work for owners of other buildings. They are frugal. Their only splurge is travel, for which they allocate $15,000 a year. For now, they are millionaires who can’t afford to live up to their assets.

One issue they face is age, for Jack, who maintains their rental building, figures he can’t do it forever. He expects to hire a management company eventually, reducing backaches but adding to the cost of upkeep. Julia, 13 years younger, likes her work but wants to quit her job to spend more time with Jack while he is able to travel.

The other issue is what is sometimes called “asset drag.” Simply put, they can’t afford to sell what they’ve got. “Can we afford to give up my job?” Julia asks. “If we can afford it, could we also double our travel expenditures to $30,000 per year? Can we afford a boat that could cost as much as $100,000 or a travel trailer with a cost up to $20,000? And should we sell our $1-million house and downsize to a condo with a nice view?”

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple. 

“Given that 66% of their total assets are tied up in their $1-million house and their $900,000 apartment building and that the apartment building is half their invested money, any asset switches have to be done with great care,” he explains.

Cash tied up in assets

Jack and Julia want to swap their pleasant lives in B.C. for exotic travel. They have trekked in Argentina and camped in parks in Kenya and are eager for more of the same.

If they want to extend their time away from home, it would make sense to sell the house and get a condo. They have priced condos and found that what they like is not a lot less expensive than their house. But they would have to realize $200,000 or more to make a move worthwhile. They will either have to shop diligently to find a bargain or accept that they cannot have both the manse and a doubling of their travel budget, the $100,000 boat and the $20,000 trailer, Mr. Moran suggests.

It would be possible, of course, to keep the house as is, buy a used trailer and a $20,000 boat and travel for no more than $10,000 a year even on a retirement budget, but neither Jack nor Julia seem to want to go through retirement in steerage. About half the couple’s current income after tax and deductions comes from their apartment building. As a business, it generates $57,600 in annual rents, from which they deduct  $5,700 for property taxes, $5,000 for maintenance, $10,725 for mortgage interest, $2,700 for insurance and $1,500 a year for electricity for halls and common areas.

Their net income before income taxes is $31,975. That is a 3.6% yield on the current value of the property and 6.3% on the difference between the $900,000 price tag and a $390,000 mortgage on the property. After all expenses, the return on their original investment is about 20% a year. It would be hard to match with other investments. They are caught by a paradox — the apartments building is simply too profitable to sell, Mr. Moran says.

Planning retirement income

Assuming that Julia retires next year, the couple will have to live off of savings and rent. Jack’s CPP and OAS will not begin for another five years. If the couple’s savings were spent evenly to Julia’s age 90, assuming growth at 3% over the rate of inflation, they could withdraw $37,529 a year before tax, Mr. Moran estimates. Rental income would add $31,975 for a total of $69,504 a year.

If Jack waits to age 65, his CPP will begin at $8,640 a year. In the same year, he can begin to receive OAS at $6,456 a year. With Julia’s annual $8,880 employment pension, their income would rise to $93,480 a year in 2011 dollars and hold for another 10 years.

millionaire-on-paper


Julia’s CPP and OAS start when she is 65 and Jack is 78. She would lose a $2,280 monthly pension bridge. Even so, their family income would be $103,416 a year in 2011 dollars. By this point, the mortgages would be paid.

The family’s income after Jack is 65 will rise in steps. Assuming a 25% average tax rate for each person and careful pension-splitting, the couple would have after-tax income of $70,110 beginning at Jack’s age 65, then $77,562 beginning when Julia is 65, all in 2011 dollars. Their monthly income after removal of charges for their line of credit, RRSPs and residual savings will be more than they now spend. In the end, the problem is that even with close to $2.5-million in net worth, the couple can’t really live the life of millionaires.

“They can retire with a good life but not a grand life. The core issue is asset liquidity. The $1-million house produces no income and the apartment building is too lucrative an asset to sell,” Mr. Moran says. To see Jack and Julia’s full financial statement, visit financialpost.com/personal-finance Need help getting out of a financial fix?

(c) 2012 The Financial Post, Used by Permission