This Ontario couple has nearly $4 million in assets, but the real-estate heavy mix needs to change

They have four rentals, with a present value of $2.29 million, yielding a 3 per cent return. Sell the rentals, expert advises

Property Investment And Saving Growth Or Business Financial Hous
Author of the article: Andrew Allentuck
In Ontario, a couple we’ll call Fred, 55, and Mary Lou, 51, have built up assets of nearly $4 million, chiefly in real estate. They have four rentals with a present value of $2.29 million and a $1.1 million house, which they have financed with several mortgages totalling $1.7 million, including a line of credit on their home. Fred and Mary Lou have jobs that pay them a total of $210,800 per year.
For now, their plan is to work another seven to ten years to generate sufficient capital to provide retirement income of $120,000 before tax and $100,000 as a marriage gift to their adult child.

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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Fred and Mary Lou. His view — they have too much real estate and too little diversification, but overall they are in excellent shape.

Savings and real estate

Let’s look at how the couple saves. They put $2,123 per month into RRSPs, which have a present combined value of $482,000. They put $1,000 per month into their TFSAs with a present value of $108,000.

Their equity in their four rental properties, $938,000, is the difference between estimated current value and what they owe in mortgages. They receive rent of $97,656 per year and pay interest, taxes, condo fees, insurance and related costs of $72,196. That leaves net rent of $25,460 on owner’s equity. That’s a three per cent average return. For the risk of vacancy, default, adverse neighbourhood change, etc., it’s pretty crummy. But it is a positive return and in today’s tough post-pandemic economy, it’s potentially attractive. Real estate has thrived, but at the moment they could do much better in stocks, even in diversified real estate investment trusts. There would be visible volatility, but also greater diversification than their rental apartments.

Alternately, selling two properties that have returns on equity below three per cent should be considered, Moran says. If they were sold, portfolio liquidity and long-run returns would be likely to rise. They could sell two properties with returns of 1.9 per cent and 2.8 per cent and keep two others with returns on owner’s equity of 3.5 per cent and 5.2 per cent. However, for simplicity, we’ll assume all four are sold.

Retirement plans

Retirement income projections calculated a decade before 65 are chancy. Nevertheless, there are some solid figures we can use. Fred and Mary Lou came to Canada and became residents at ages 37 and 34, respectively. By age 65, Fred will have been resident in Canada for 28 years and Mary Lou for 32 years. They will therefore quality for fractional OAS which requires 40 years residence in Canada between the ages of 18 and 65. Mary Lou will have 80 per cent of OAS qualification and Fred 70 per cent. With OAS presently paying $7,500 per year, they would be entitled to $6,000 and $5,250, respectively, at age 65.

For Canada Pension Plan benefits, which depend on contributions rather than just residence, Fred can expect $626 per month and Mary Lou $754 per month, starting when each turns 65.

Fred will receive a defined-benefit pension of $18,500 from age 62 to 65 and then $16,500 per year thereafter. Mary Lou has a defined-contribution plan, essentially a company-assisted RRSP.

RRSP present values based on Fred’s RRSPs and one defined contribution pension, present total $482,000 with $30,468 annual contributions for Fred, with growth at three per cent per year after inflation will become $1,007,528 at Fred’s age 65 years when they consider a first time to retire. Those sums would support payouts of all income and capital for 34 years of $46,289 to Mary Lou’s age 95.

The couple’s TFSAs are fully funded. The current value, adjusted for the market meltdown, is $108,000. If each adds $6,000 per year and the accounts grow at three per cent per year after inflation, they will become $286,837 in 10 years at Fred’s age 65 and pay $13,178 for the following 34 years.

Selling all rentals

If they sell all four rental properties with taxes and fees paid and receive $1.1 million, then with the mortgages paid off, their remaining equity would be $938,000. If that money were invested and they added the $25,476 annually that they would not have to put toward mortgage principal paydown, then with three per cent growth after inflation the total would become $1,561,400 in ten years when Fred is 65. That sum, generating three per cent after inflation for the next 34 years to Mary Lou’s age 95 would produce $71,718 in taxable income per year to the exhaustion of all capital and income.

If we add up all projected income for the couple from retirement when Fred is 65, they would have $71,718 income based on equity obtained from former rentals, RRSP income of $46,289 per year, his OAS of $5,250 per year, CPP of $7,512 per year and $13,178 annual TFSA income. That adds up to $143,947 with all but TFSA income taxable. After splits of income and 27 per cent average tax on all but their TFSA income, they would have $9,053 to spend per month. That’s more than their present allocations of $6,675 per month not including RRSP and TFSA contributions.

When Mary Lou turns 65, they could add her annual OAS benefit, $6,000, and her annual CPP benefit, $9,048. That would push total pre-tax income to $158,995. After 28 per cent tax on all but TFSA income they would have $9,847 per month. With care to split eligible income, they would avoid the OAS clawback that takes 15 per cent of taxable income over $79,054 at current rates. Their income surplus to living costs would be $36,000 or more, which they could save for a marriage gift or just give it and live with less capital still surplus to their cost of living.

“Frugal living has given this couple the ability to be generous to their daughter when she marries and prosperous in retirement,” Moran concludes. “Security is their reward.”

Retirement stars: 5 ***** out of 5

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