Five years after retirement, Garth and Karen are wondering how long they can sustain their lifestyle without selling their home. He is 69 years old, he worked in health care, she is 65 years old, she worked in education. They have five adult children, one of whom they are now helping with rent.
“We’re retired, married for three years and living in Toronto,” Karen writes via email. They use Canada’s Pension Plan, old-age insurance, Karen’s pension, RRIF withdrawals, and a line of credit to generate income. During their working years, both of them had good incomes. Garth has $ 1.2 million in his registered retirement fund and their joint home is valued at $ 3 million. Karen’s labor pension pays $ 55,380 a year, adjusted for inflation.
They are concerned that their mortgage will be renewed this year, giving them the opportunity to consolidate some or all of their debt.
“Given the rise in interest rates on the line of credit, we are wondering if we should combine the lines of credit with the mortgage during the renewal, use funds from RRIF to pay off the mortgage and line of credit in full, or sell the house,” Karen writes.
“We hoped to stay in this home for more than five years and use the proceeds from the sale later,” she adds. “Can we afford to stay put and get rid of the excruciating worry that we won’t have enough money to live a long life, and ideally leave some funds for our children?” Their monthly expenses are $ 15,455 or $ 185,460 per year.
“We have a lot of value on paper, but we feel the need to keep an eye on investment accounts and wonder how we should worry.”
We asked Matthew Sears, vice president and certified financial planner at TE Wealth in Toronto, to take a look at Garth and Karen’s situation. Mr. Sears is also a Chartered Financial Analyst.
What the expert says
Mr. Sears proposes to start by repaying the smaller of the two lines of credit ($ 16,000) at an interest rate of 7.05 percent. Alternatively, they can invest it in a mortgage on renewal. Another line of credit – $ 325,000 at 2.95 percent – has a lower rate than their existing mortgage. So, depending on what rate they are extending the mortgage at, they can enter the LOC or leave it as it is.
They currently only pay interest on the LOC. “If they put them in a mortgage, they also have to start paying the principal,” says the planner.
Of the options suggested by Garth and Karen, withdrawing money from Garth’s RRIF to pay off their lines of credit would be the least practical, as it “would be taxing high,” says Mr Sears. Garth withdraws $ 120,000 a year from his RRIF. “To receive $ 341,000 to repay the lines of credit, he would have needed to withdraw an additional $ 680,000 from his RRIF account.” (On income over $ 220,000, Garth will be in the group with the highest tax rate at 53.53 percent.) They can use the tax-free savings account for part of the repayment, but that would still require an additional $ 535,000 withdrawal, says the planner.
Sears says whether Karen and Garth can afford to stay in their home for another five or ten years depends on what they do with their current debt and their willingness to retire the debt. He looked at several alternatives based on a 5 percent annual rate of return on their investment, 2 percent inflation and $ 146,280 per year of lifestyle spending, excluding debt repayments. When the house is sold and they are downsized, it is estimated that $ 1.5 million minus the remaining debt will be added to their retirement portfolio.
In the first scenario, they invest a smaller LOC in the mortgage and continue to pay interest only on the larger one. In the second scenario, they renew the mortgage and exit the RRIF to pay off the larger LOC. In three cases, they extend the mortgage and pay the LOC with withdrawals through TFSA and RRIF. In the fourth scenario, they put the LOC on a mortgage and pay the full amount over eight years. Sears concludes that the latter is the best option – consolidating all of his debt into a mortgage and paying it off over the next eight years.
“All scenarios lead to Karen (the youngest of two) reaching 94 years of age with the remaining investment assets,” says Mr. Sears. She ends up investing at 95. In all scenarios, they retain their reduced ownership, which can be used to cover the deficit. If the rate of return is 4 percent instead of 5 percent, Karen will run out of investment assets at age 92. “In all scenarios, they will be able to stay in their home for the next five years,” says Mr. Sears. In scenarios one and four, they can keep their home longer: nine years in the first scenario and eight years in the fourth scenario, the planner says.
Should they worry about their investments?
“The portfolio does represent a significant source of their cash flow over the next five to eight years, until they sell the house and invest the proceeds,” says Mr. Sears. They receive about 8.6% of the portfolio value annually. “Even when they get some of their equity back, they are going to attract about 6.5% of the portfolio value in the first year,” and then grow steadily.
“For example, in 2031, after adjusting for inflation, they will have expenses of $ 178,373 plus income tax of $ 30,000, so they will need about $ 208,000,” he says. CPP, OAS and Karen’s pension covers about $ 115,000, so $ 93,000 will need to be pulled out of the portfolio, which by then will include the proceeds from the sale of the home. “It will be important for them to keep track of their portfolio throughout their retirement.”
According to the planner, low interest rates make it difficult to get the required rate of return without including stocks, and therefore risk. Garth’s portfolio consists of 60 percent fixed income shares and 40 percent shares. Karen’s RRSP is 35 percent fixed income and her TFSA is 15 percent fixed income. It will be important for them to maintain a balanced portfolio that can withstand periodic 20-30 percent drops in stock markets so that they don’t have to sell low to cover their living expenses.
“In times of rising stock markets, they will feed their needs with stocks, and if the market falls, they can use fixed income or cash.”
People: Garth, 69, Karen, 65, and their children
Problem: Should they transfer their lines of credit to mortgages when the renewal comes this year? How long can they afford to stay in their home?
Plan: Weigh the alternatives. Depending on what rate they can renew their mortgage at, it may be most appropriate to renew the lines of credit and schedule the entire amount to be paid over eight years.
Pay: They will still have to keep a close eye on their investments, but they can be confident that they can keep their home for a few more years.
Monthly net profit: USD 15 455
Resources: Cash USD 1000; her TFSA is $ 82,000; her RRSP is $ 108,000; his RRIF is $ 1.2 million; the estimated present value of her retirement plan DB $ 1,072,325; residence of $ 3 million. Total: $ 5.46 million
Monthly expenses: Mortgage USD 2065; property tax USD 1050; home insurance $ 450; utilities $ 570; service, garden $ 500; car rental USD 560; other transportation USD 700; grocery $ 1,400; rent of an adult child (partial) USD 1000; clothes $ 120; line of credit 1200 US dollars; gifts, charity US $ 475; vacation, travel 1000 US dollars; lunches, drinks, entertainment $ 750; personal hygiene USD 150; club membership $ 630; golf 210 dollars; sports, hobbies 280 $; subscriptions, other USD 185; healthcare $ 440; medical insurance $ 30; life insurance 1000 US dollars; telephones, TV, internet $ 440; her medical insurance is $ 250. Total USD 15 455
Obligations: Mortgage $ 167,500; credit line USD 325,000; second LOC $ 16,000. Total: $ 508,500
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