Couple Wants to Trade Bungalow for a Schooner and Cruise the Caribbean
The Problem: Successful businessman and wife, a teacher, tired of Alberta’s blizzards, wonder if they can stretch the value of their fully paid house and RRSPs for a sailboat for winter plus a year round cottage for summer.
The Solution: Test retirement income and assets for ability to cover purchase price and amount of remaining financial assets to provide retirement income, thus ensuring both security of capital and sufficient income in retirement.
A couple we’ll call Dave, 58, and Maureen, 52, want to make their dream of cruising the Caribbean come true. An experienced sailor, his plan is to trade his $750,000 house and $329,000 of financial assets — not including RESPs — for a 40 foot long sailboat with a $150,000 price tag and a $300,000 insulated cottage. They would cruise the Caribbean in winter, return to Canada in summer, and sail into the sunset. Their kids, ages 22 and 20, will have finished their university courses in a few years and be independent.
Sailboats are notoriously expensive to maintain. But Dave, who manages a transportation company in Alberta, is sure he can afford it. The only liability he and Maureen, a teacher, have is a $45,000 line of credit they are paying down at $3,000 a month. It will be eliminated in fifteen months.
The problem the couple will face is not only financing their change of residences, but estimating and covering the costs of life on the sea, even if it is for only half the year.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Dave and Maureen.
They plan to quit their jobs in four years. At that time, his present $325,000 of RRSPs generating 3% a year after inflation along with annual contributions of $16,800 a year would have a value of $438,200. With no further contributions, but with the same rate of growth of assets, he could take out $23,200 a year to his age 90, at which time the fund would be exhausted. There is, however, a problem with the portfolio, actually a grab bag of old ideas — gold mines fighting the dropping price of the metal, oil and gas producers battling the North American energy surplus, and mineral companies up against the global economic slowdown. There are no bonds, no banks, no utilities. It is unbalanced, unfocused, and unable to generate sufficient retirement income as presently structured. Dave and Maureen will have to rebuild it or risk having their retirement imperiled.
What may save their retirement will be the cash they get from swapping their present $750,000 house for the $150,000 sailboat and $300,000 cottage. Ignoring selling costs and taxes, land transfer fees and so on, the trade would provide them with $300,000 net cash. If that sum is invested at 3% over the rate of inflation, it would provide an additional $13,800 a year assuming that the capital would be exhausted by Maureen’s age 90.
On top of the investment income, Maureen will have a $46,800 annual pre-tax pension from her civil service job. She can buy back 2.6 years of service at $31,000 a year. The money would come from her RRSP balance, $60,000. Their $23,200 annual income from RRSP investments, $13,800 from the house sale remaining cash balance and Maureen’s topped up pension would be $83,800 a year before tax or $5,935 a month after 15% average tax. This would be their initial retirement pre-tax income. It would cover present expenses net of savings and child care.
They can wait to age 65 to draw their Canada Pension Plan benefits, which will be $12,150 a year for Dave and, allowing for early retirement, 90% of the maximum or $10,935 a year for Maureen. Finally, when Dave is 65, he can receive Old Age Security at $6,599 a year in 2013 dollars. Maureen will have to wait to age 67 to receive the same amount. In total, their permanent retirement income will then be about $120,100 a year, some of which will be a non taxable return of capital and untaxed TFSA withdrawals. After splitting pension income and paying an average 20% rate of tax, they would have about $8,000 a month to live on. The Old Age Security clawback, which begins in 2013 when individual net taxable income exceeds $70,954, would not affect them while both are alive. The eventual survivor’s income with no pension splitting would be subject to the clawback, however.
Using their present budget, $10,250 a month and subtracting RRSP savings and debt service charges, a total of $4,400 a month, they would need just $5,850 a month, which would be amply covered by their permanent after tax income and their transitional retirement income before each is able to receive Old Age Security benefits. The costs of running the sailboat and keeping the cottage, say $750 a month for the boat and $300 average cost on a yearly basis for the cottage, would add $1,050 to their costs, but still be within expected permanent retirement income.
Forecasts are not guarantees and there are a lot of ifs in this one, Mr. Moran admits. First, there will be an income shortfall in the four years after retirement at 62 before Dave applies for Canada Pension Plan benefits and the nine years before retirement at 56 that Maureen applies for full benefits. They could each apply at 60, but the 0.7% a month or 42% permanent penalty is high. They could finance any shortfall by tapping Dave’s RRSP, Mr. Moran suggests.
The largest unknowable would be the difference between the proceeds of their home and the cost of the new one. Second is the cost of operating and insuring the sailboat. Dave’s estimate of insurance costs, perhaps $150 a month, could be low. The costs of maintenance as well could be higher than Dave and Maureen have estimated.
Finally, there is the problem of the couple’s investment portfolio, which desperately needs to be rebuilt to provide both asset security and income predictability.
“To go from running an office and teaching school in Alberta to sailing the high seas takes courage,” Mr. Moran says. “The plan Dave and Maureen have outlined can work, but there is a lot more they have to do to build the security that they have now and that they will put in jeopardy when they are at the mercy of tropical storms. To keep medical costs in check, they need to remain residents of Alberta or another province and buy travel medical insurance. They have to do more work to ensure that their venture will be the dream they expect.”