A couple we'll call Brenda, who is 36, and Phil, who is 37, live with their 17-month-old daughter in a B.C. resort town. Brenda is a management consultant; her monthly income after tax is about $6,000. Phil, a part-time civil servant, brings home $3,000 a month after tax. Their lifestyle is nomadic, with frequent trips to the U.S., Latin America and Eastern Canada.
They want to retire at 60 and are considering buying a home.
They worry that by living to the fullest today, travelling rather than putting down firm roots, they may be impairing their ability to afford a home of their own. “How can we give ourselves something to fall back on while not completely changing our lifestyle?” Brenda asks.
What our expert saidFacelift asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Brenda and Phil to test the costs of their choices and to plan their financial future.
“Brenda and Phil have chosen freedom over material possessions,” Mr. Moran notes. “Contrary to what is often widely thought, they can become quite well off without owning real estate.”
Investing without a house Brenda and Phil pay $1,300 rent a month. Their decision to avoid owning a home may have been advantageous, Mr. Moran says. They missed the great meltdown in housing prices. Not having a mortgage has meant that their $4,000 monthly rate of savings – $1,000 to registered retirement savings plans and $3,000 cash for taxable savings – has been preserved
Their registered retirement savings plans will grow with the addition of $1,000 a month, adding to their present $78,000 RRSP balance. By the time Phil is 60, their RRSPs, growing at a real rate of 3 per cent a year, will total $555,060, Mr. Moran estimates. These funds would produce income over the years to Brenda's age 90 of $26,944 a year, the planner calculates.
If Brenda and Phil continue to rent, they will be able to build up savings for other investments at $3,000 a month. Assuming that assets generate a 3-per-cent annual return after inflation, that Phil sets up a Tax-Free Savings Account (TFSA) to match Brenda's existing TFSA and that they contribute $10,000 a year to the two accounts, then by the time Phil is 60, they will have balances of $334,265. That sum would provide tax-free income of $16,226 a year in 2009 dollars until Brenda is 90, Mr. Moran estimates.
Brenda and Phil will also be eligible for full Old Age Security at a rate of $6,204 per person per year. If both contribute to the Canada Pension Plan at the maximum rate, then they would each be eligible for CPP benefits of $10,905 a year.
If the couple put $5,000 into another TFSA each year, their non-registered savings will be reduced to $26,000 a year and non-registered savings would grow to $869,000 by the time Phil is 60, assuming a 2-per-cent annual return after inflation and tax. This sum would produce annual income of $42,186 a year, the planner estimates.
Their retirement in financial terms would therefore work as follows: From ages 60 to 65, they would have $26,944 from RRSPs, $16,226 from TFSAs and $42,186 from taxable investments for a total of $85,356 a year. At age 65, the couple would gain $6,204 OAS each plus as much as $10,905 CPP each for a total of $119,574.
The Cost of Home Ownership
The couple pay rent of $1,300 a month or $15,600 a year. A similar house next door just came up for sale at $529,000. Taxes are $3,048 and maintenance fees are $2,028 a year for yard care and snow removal.
Brenda and Phil could buy the house they are renting. If they each take $25,000 from the RRSPs as a Home Buyer's Plan loan – they would have to add $11,000 to Phil's and then wait 90 days before taking out the money – and add $60,000 from non-registered investments, they would have a $110,000 down payment. If they get the property for $500,000, their mortgage would be $390,000. With a 23-year amortization that will have the house paid for by the time Phil is 60 and a 3.75-per-cent mortgage rate for five years, they would have to pay $2,105 a month of which $1,120 would be interest, on average, for the five years.
Therefore, the current cash flow required to buy and keep the house would be $25,260 annual principal and interest payments on the mortgage plus $3,048 taxes plus $2,028 maintenance for a total of $30,336 plus the costs of mortgage and property insurance.
By continuing to rent, the couple will find it relatively easy to maintain their nomadic lifestyle. Moreover, they will preserve money to increase their child's registered education savings plan contributions from $100 per month, the current rate, to $208 or $2,500 a year. That would qualify them for the maximum $500 Canada Education Savings Grant, which is set at the lesser of $500 or 20 per cent of RESP contributions each year. The existing $1,700 RESP balance would grow to $69,018, assuming a 3-per-cent real annual growth and would provide $17,400 a year for a four-year course at university, the planner says.
“Ownership of real estate has been as a good way to pace inflation. But where the cost of ownership is vastly higher than renting, renting wins,” Mr. Moran concludes.
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