‘Free Spirit’ Couple Want to Carve Out a Retirement
Couple needs to build some certainty and rely less on the whims of the housing market.
Couple have bet their retirement on a single commercial property and life insurance
Cut insurance costs, pay down debts, generate substantial rate of RRSP growth
In Alberta, a couple we’ll call Bill and Wendy, 51 and 48, respectively, have raised six children. Their salaries currently total $9,300 a month after tax and other deductions. Their wealth is in real estate — their home and a commercial property that generates gross rent of $6,670 a month but which, after all expenses, produces a small loss. Their financial assets are $76,218 of RRSPs and $2-million of life insurance with modest present cash value. They have no company pensions and no tax-free savings accounts. With financial surgery — converting to less expensive insurance and using savings to pay down debt on the rental property, they can get out of their peril.
“We are free spirits, tend to go with the flow of things and enjoy life simply,” Wendy explains. “But there have been health issues, for Bill had metabolic problems, now cured, that forced him to take a large pay cut from $100,000 a year before tax to $60,000. It was a rough transition with pay falling a decade ago and then returning to six figures.”
Today, Bill, a manager in an industrial plant, earns $132,000 a year before tax. Wendy, an administrator in a public relations company, earns $36,200 a year before tax. They are paying off their approximately $225,000 commercial property mortgage and $257,000 line of credit for the property and their equity is thus climbing in spite of a small monthly loss after expenses.
The commercial building will pay itself off in due course. Assuming that the 3.0% mortgage interest rate does not change, the mortgage on the building will be gone in 12.5 years. The line of credit in about 10 years. At this point, Bill will be 63 and Wendy will be 60. Using present rent figures, they will have gross cash coming in at $80,040 a year for a building with present value of $548,000. That’s a 14.6% gross return before taxes and maintenance. However, a one-building retirement plan is perilous. A bad tenant, mortgage interest rate rises or zoning changes could wreck not just the building’s cash flow, but their financial lives, for their debts are equal to 75% of their assets.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple.
“Their balance sheet badly needs a reno,” Mr. Moran says. “They are almost $800,000 in debt, though they have $2-million of life insurance. They are better prepared for death than for life in the years following the end of work.”
They have group life insurance coverage and four of their own policies which bring their total life insurance to about $2-million. They pay $4,800 a year in premiums for just their own policies. Best bet — cash in whole life policies and replace their present term policies which average premiums over 25 years with a new policy with the same death benefit but with premiums averaged over 10 years, Mr. Moran suggests. There are numerous benefit and premium choices. However, a $2,500 annual saving would be possible. In a decade, the majority of their debt would be gone and they will need much less insurance to cover debts.
If the whole life coverage is cancelled, there could be tax implications, the planner warns. The net proceeds should then go to a spousal RRSP for Wendy. The refund at about 39% of the RR SP contribution should be used to reduce their personal line of credit. It would be about $2,300, he estimates.
In three years, two personal lines of credit which total $55,568 will be paid off. They can direct the $1,500 a month payment to their home mortgage, interest on which is not tax deductible, and thus cut down the time it will take to pay it off to about six years. They will have saved $27,500 of interest. At this point, Bill will be 57. The commercial line of credit will be paid off at about the same time.
Building Retirement Assets
Once the house mortgage is paid off, they will have liberated $1,500 a month on the line of credit plus $1,750 on their residential mortgage. That yearly total of $39,000 can be used to fill more than $240,000 of RRSP space and more of that will be available in the eight years to the time Bill is 65. They can use $6,026 from cashing in a whole life policy to add to their $76,218 in present RRSPs and add the $39,000 a year to their RRSPs to Bill’s age 65.
If he can get a 3% return after inflation, he would have $461,400 in RRSPs, including a spousal plan which recognizes his wife’s lower income and future tax bracket. He should investigate low-fee mutual funds or exchange traded funds to get the most out of his growing capital. The couple can start tax free savings accounts as their monthly cash flow grows, Mr. Moran suggests.
The commercial building will pay itself off in due course. Assuming that the 3.0% mortgage interest rate does not change, the mortgage on the building will be gone in 12.5 years. The line of credit in about 10 years. At this point, Bill will be 63 and Wendy will be 60. Using present rent figures, they will have gross cash coming in at $80,040 a year for a building with present value of $548,000. That’s a 14.6% gross return before taxes and maintenance.
The RRSP capital could support payouts of income and all capital of $23,900 a year for the 28 years from retirement when Bill is 65 to the time that Wendy is 90. They could add income from their commercial building, which will then be free of debt. Basing its cash flow on 2014 rents of $80,000 a year and taking off $12,400 for maintenance and taxes, they would have about $67,600 of property income.
Each partner should receive $12,460 of Canada Pension Plan benefits in 2014 dollars and, at 67, $6,620 Old Age Security in 2014 dollars.
Their retirement income, when Wendy is 67, would total $129,660 before tax. If eligible pensions were split, each partner would have $64,830 before tax. They would have no exposure to the OAS clawback which currently begins at individual net income of $71,592. After 20% average income tax, they would have about $8,600 a month to spend. With all debt service charges eliminated, their income in retirement would be about 25% higher than it is now.
For two free spirits who have devoted their lives to raising six children and who have scant financial assets, that’s not a bad outcome, Mr. Moran says.
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