National Post Article: Couple wonders – Is saving $500,000 in investment income enough for couple to meet their retirement goals?

The National Post asked me to review the retirement plan of a mid-career couple from Ontario, Kathy and Trevor, who are trying to simplify their finances and meet some big goals before Kathy retires at 55.

Kathy is 50 and Trevor is 53. They live in the GTA and have two adult children about to head off to university.

They’re hoping to spend three months every year travelling once Kathy retires, and want to make sure they can support their kids if needed.

With good incomes, defined benefit pensions, a rental property, and a strong desire for freedom, they’re trying to figure out the smartest way to use their money today to secure the future they want tomorrow.

Right now, they’re paying $2,400/month on a $240,000 mortgage on their $1.2 million primary residence.

They also own a rental property worth $620,000 with a long-term tenant and a $178,000 mortgage.

They’ve built up $57,000 in investments and are considering a GIC ladder strategy to slowly build up $500,000 in accessible funds before retirement.

They’ve also dabbled in cryptocurrency and are wondering what to do about life insurance options offered by their employer.

They’re weighing two major options:

1. Should they sell the rental property and use the proceeds to pay off their home and invest the rest?
2. Or should they refinance the rental to pay off their home mortgage and keep the property?

One common misunderstanding we’ll address in this piece: Many rental property owners believe mortgage interest is always tax deductible, but it’s not that simple. 

In Canada, interest is only deductible if the borrowed money was used to buy or improve the rental property. Tax deductibility depends on the purpose of the loan, not what was used as collateral.

In this article, I’ll answer their key financial questions:

• Is it realistic to save $500,000 and pay off their mortgage in the next five years?
• What’s the fastest and simplest way to get there?
• Should they refinance the rental to pay off their home mortgage instead of selling it?
• What about their RRSPs and Tax-Free Savings Accounts (TFSAs)? Should they contribute if they already have pensions?
• Where does the $8,000 in cryptocurrency fit into their plan?
• What should they do about their life insurance policies?

CLICK THE LINK BELOW TO READ THE ARTICLE BY MARY TERESA BITTI:

Is saving $500,000 in investment income enough for couple to meet their retirement goals?

Financial Plan

To retire at age 55 for Kathy and 60 for Trevor on their current lifestyle, less their mortgage payment and youth sports costs, plus $20,000/year that will allow them to spend three months each year exploring a new destination and help their two young adult children, they need to accumulate $500,000.  Their goal of wanting to save $500,000 is the right amount. Their current investments are only $57,000 and should grow to $73,000 by retirement, but that still leaves them $425,000 short. To save this with the GIC ladder they discussed, they would need to save $6,300/month.

They also want to pay off their mortgage by retirement. Their current payment will pay it off in just over 11 years. To pay it off in 5 years when Kathy retires, they would need to increase their mortgage payment by $2,200/month (from $2,400/month to $4,600/month).

In short, they need to invest $6,300/month to save the $500,000 they need and increase their mortgage payment by $2,200/month, but they only have about $1,700/month cash flow available now.

Their options are to work longer, spend less now and after retirement, require themselves to work part time, or sell their rental property.

The easiest solution is to sell their rental property. Their return on it is very low, since they net only $1,500/year in rent income while they have $440,000 equity in the property. The property will likely grow in value over the years and give them some additional money in the future, but their life goals can be achieved within only a few years if they sell it and use the proceeds to pay off their current mortgage and invest the remaining amount, which should be about $170,000.

With their mortgage paid off, they should have just over $4,000/month available cash flow. They would need to invest $3,100/month and the $170,000 remaining proceeds to accumulate $500,000 by the time Kathy retires.

If they invest all of it in balanced mutual funds, like their existing investments, instead of in the GIC ladder, then they should only need to invest $2,400/month, instead of $3,100/month.

Questions & Answers:

Q1/ They want to pay off the mortgage on their primary residence and build up $500,000 in easy-to-access investment income – they’re thinking about a ladder strategy for guaranteed investment certificates – that will allow them to spend three months each year exploring a new destination and help their two young adult children, should they need it. 

Saving $500,000 by the time Kathy retires is the right amount. It would be more effective to invest for some growth, instead of a GIC ladder, since their retirement is likely to be about 40 years.

Q2/ He and Kathy are considering two strategies. Sell the property and use the proceeds to pay off their current mortgage and invest the rest. Or, keep the rental property and refinance it to pay off the mortgage from their primary residence. What does the expert recommend?

Refinancing their rental property to pay off their home mortgage creates a tax issue for them. Their home mortgage is not tax-deductible, but the rental mortgage is. Combining them would give them a mortgage that is only partly tax-deductible, and they would need to calculate how much of the interest is deductible.

Many rental property owners seem to think that interest on any rental mortgage is tax deductible, however the mortgage is only deductible if the money was used to buy or renovate the rental property. Tax deductibility is based on the purpose of the money, not based on which property is used as collateral.

Q3/ RRSPs, but aren’t sure if they should maximize contributions as they both have pension plans. 

Both Kathy & Trevor are in 43% marginal tax brackets now and expect to retire in the 31% marginal tax bracket. Therefore, RRSPs provide a benefit for them greater than TFSAs.

They should use their $170,000 net proceeds from selling their rental property and their $3,100/month savings to maximize their RRSPs first and then their TFSAs.

They should only deduct $7,000/year for RRSP for Kathy and up to $35,000/year for Trevor to get 43% tax refunds on their contributions.

They can contribute their lump sum to maximize their RRSPs, but then deduct the optimal amount each year and carry forward the rest.

Q4/ Invest $8,000 in crypto to see what happens. “I’m not sure where it falls into overall planning and funds for crypto are limited

Crypto has provided very good returns the last few years, but is very difficult to use in a financial plan. This is because we have no idea what the future growth will be. With stocks or bonds, we have a good idea based on history of the likely long-term returns. Crypto, however, could collapse or could continue to grow exponentially. There is no way to know.

Their best advice is to keep a bit if they like, but don’t consider it part of their retirement portfolio.

Q5/ They have an opportunity to convert to whole life policies, but aren’t sure if that is necessary – especially since premiums will likely be expensive. Should they forego the policies and direct that money to exchange traded funds or other savings products?

Kathy & Trevor need close to their full combined income to achieve their life goals. If something happens to one of them before they retire, the survivor essentially needs to have insurance to replace their after-tax income. To do this, they need $400,000 life insurance on Kathy for the next 5 years and $600,000 on Trevor for the next 7 years until they are both retired.

They have $250,000 in term life insurance on each of them, which is not enough. Considering they should sell their rental property, which should clear $440,000, that can cover the difference for the next few years. It is likely not worthwhile to get larger term policies for only the next few years.

After they retire, their need for life insurance is focused on how much pension income a survivor would lose. This depends on the survivor benefit for their pension plans. If it is available, they should choose 100% survivor benefit, so that the survivor would continue to receive the same pension. In that case, they do not really need any life insurance after they retire.

The default on most pension plans is that the survivor would get 60% of the pension. They would also lose the OAS and likely the CPP. The survivor can get 60% of the CPP, but only up to the maximum CPP. If they both already receive the maximum CPP, then the survivor would not get any of their partner’s CPP.

This means that if Trevor outlives Kathy, he would lose about $40,000/year of pension income. If Kathy outlives Trevor, she would lose about $60,000 of pension income.

The survivor would likely spend less than they spend together, but most of the fixed costs remain. The survivor may be able to live on $20,000/year less. Therefore, losing $40,000/year or $60,000/year of pension would require significant reduction in lifestyle. To replace this with only $20,000/year less spending, they might need $400,000 life insurance on Kathy and $700,000 on Trevor for life.

If this is the case and they cannot get a 100% survivor benefit (or at least $80,000), then converting their term life to a term-to-100 policy would be beneficial. This would cost less than a whole life policy.

Ed