Selling income properties will give Alberta couple’s retirement finances the lift they need
Story by: Andrew Allentuck | Financial Post
In Alberta, a couple we’ll call Chuck, 63, and Ellie, 64, worry their retirement income won’t support their way of life. Planning to retire from his work as a marketing manager for a large company, Chuck accepted an offer of six months’ salary beginning in February. After withholding, he will net about $38,000 after tax. Ellie retired two years ago from her work as an administrative assistant on contract for a large company, which did not provide a pension for temporary workers.
Their present monthly income is composed of Ellie’s $420 CPP, Chuck’s present income of $9,150, $800 in rental income from two properties and Chuck’s $735 a month pension from a former job. It adds up to $11,105 a month before tax, about $9,000 after tax on Chuck’s income and none on Ellie’s.
That income is more than sufficient for present spending of $4,755 a month net of savings, but when Chuck retires he’ll have just six months’ salary as a retirement package — and then nothing more. Their standard of living is in jeopardy.
“Can we enjoy the lifestyle we desire — doing volunteer work internationally with Habitat for Humanity for six months at a stretch?” Chuck asks. “Do I need to work part-time and how do we make provisions for our son if a problem he has with his stomach worsens?”
Family Finance asked Graeme Egan, a financial planner and portfolio manager who heads CastleBay Wealth Management Inc. in Vancouver, to work with Chuck and Ellie.
The Balance Sheet
The couple’s net worth is about $1.22 million. Real estate makes up 70 per cent of their assets and has provided, via mortgages, a good leveraged return on equity. The liabilities add up to $677,671 — $536,349 of that is mortgages on rental properties, the interest on which is tax-deductible. For now, their financial assets ($577,152) include $129,723 of cash, the result of a sale of a U.S. vacation property. The sum includes a $50,000 down payment for their son’s condo.
In preparation for retirement, the rental properties need to be reviewed, Egan says. Their combined equity is $331,000 and Chuck and Ellie owe $536,349 on them. Their mortgages have low interest rates averaging 2.5 per cent. The properties and their leveraged returns have been profitable. But times change and it is time to reduce leverage and the risks, such as vacancy, that go with owning rental property.
The couple are considering selling one property in order to raise cash to pay off their own home mortgage. If sold, it would net its estimated price of $408,500, less the $216,916 mortgage. After perhaps $20,000 in selling expenses, they would have $171,584, which could be used to discharge the $141,322 home mortgage. There would be a capital gain on the net sale price, less the $330,000 they paid. If they do get a $50,000 profit, they would have tax of perhaps $10,000 to pay, Egan estimates. That would leave $20,262 to be added to financial assets, bringing the total up to about $597,500, not counting equity in their son’s home.
Building up financial assets
Their other property returns $4,800 a year, 3.7 per cent with no inflation adjustment. The return provides income and growth of the owner’s equity: The property has a present estimated value of $449,000 and a mortgage of $319,433, for net equity of $129,567. In the Alberta housing market, prices are under pressure. The property has provided a good return and security, but it is time to consider sale, Egan says.
Were they to sell it and realize perhaps $110,000 after selling expenses, they could add that sum to financial assets, bringing the total to about $707,500. If that sum is annuitized on the same basis — that is, expended in full in 26 years — and the three per cent return after inflation maintained, they would have investment income of $39,600 a year, or about $3,300 a month before tax. The annuity payout method, which is only a calculation and not a suggestion to buy an annuity from an insurance company, would reduce the estate they leave for their son. They could retain capital just by limiting spending and use TFSAs or other envelopes to conserve his inheritance, Egan notes.