A lady we'll call Lucy has made a good life working as a data manager for a company in Saskatchewan. At 53, she has take-home income of $5,245 a month. A single mom divorced for many years, she raised two children to their mid-20s and built up $663,300 in net worth. Her plan – retire at 63 and travel a bit on what she hopes will be sufficient income.
There is a problem with her plan, however. It's a condo in Arizona she purchased in 2011 for $105,000 in Canadian funds. She uses it for a few months of the year and rents it out for three to four months a year for about $9,000 (all figures in Canadian dollars) in total revenue before costs. She estimates that it has a $125,000 market value.
The rental income does not cover her costs of ownership and operation, based on finance costs of $550 a month she carries on a line of credit without regular paydown of principal and $1,040 condo fees and property taxes. That's $19,080 a year. She is running a net annual loss of $10,080 a year, eroding her savings and ultimately her retirement plans.
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Lucy.
Lucy is frugal, spending just $410 a month on food and restaurants, $25 a month on entertainment, and $75 for clothing and grooming. Ironically, it's her Arizona condo that is draining her savings. Further, Ms. Nalbantoglu says, currency issues make her problem worse.
Condo costs are killersLucy is using her monthly cash flow to cover the costs of the Arizona condo and that gap is growing, the planner says. “With the decline of the Canadian dollar against the American dollar, the costs – and her loss – are increasing. Her hope was that the increase in the value of the condo would provide her with the additional funds she needs for retirement.”
To analyze the problem, Ms. Nalbantoglu balanced the two significant drains on her income – first, her home mortgage at 2.5% with an outstanding balance of $26,000. Second, the condo, on which she owes $105,000.
For her home mortgage, she is paying $466 a month, or $5,592 a year. It has 4.6 years to run and then will be paid in full. She could sell her non-registered mutual funds with total value of $11,300 and cash out her $2,700 TFSA, using the $14,000 to reduce the mortgage to $12,000. Then her annual payments would eliminate the remaining mortgage balance in two years.
However, if her investments, which are mutual funds with good performance, beat the mortgage rate and growth of equity as she pays off her debt, as they have done and probably will do, she should keep them and just live with the very low-rate house mortgage.
The condo is the more serious problem, Ms. Nalbantoglu explains. Were she to sell it in the near future for about $120,000 (after selling costs) and take a gain of $15,000 less 10% U.S. withholding tax and pay off the $105,000 mortgage, she would capture a gain of about $18,500 less very small state tax and other fees.
Canadian tax on the capital gain would apply and probably be offset by any U.S. tax paid. The money she is shoveling into it, $1,590 monthly, or $19,080 a year, would be saved at a loss of rental income.
We are doing all calculations in loonies to keep things relatively simple.
Raising cash flow
Sale of the condo would put her ahead on a monthly cash basis. She would be forgoing future capital gains, she would end her foreign currency exposure for better (the U.S. dollar sags a little now to reduce costs in Canadian dollar terms, then appreciates when she is ready to sell, enlarging her gain) or worse (the U.S. dollar appreciates in the near term, raising her costs, then declines when she is ready to sell, cutting profit).
Timing foreign currency risk for unknown transaction dates is work for options traders. Lucy is not in that league.
If Lucy were to sell the condo, she could direct her monthly surplus from her Canadian job income to savings. If she can obtain a 3% rate of return after inflation, then by the time she retires in 10 years, her $862 monthly savings on top of $78,000 TFSA, RRSP and non-registered funds plus the $18,500 liberated from the condo would have grown to about $252,000.
If she chooses this path, she can collect her winnings and put them first into her small TFSA with $30,000 contribution room and then into her RRSP where she has $26,800 contribution room. If she puts $5,000 into her RRSP each year, she can save 35% on tax, net $1,750.
By the time Lucy is ready to retire at her target age of 63, assuming the condo has been sold, she should have $535,000 in a company defined contribution pension plan, $145,000 in her RRSP, $68,600 in her TFSA assuming $5,500 annual contributions and 3% growth after inflation, and about $146,400 in other savings. The combination of all these savings, about $895,000, could generate $26,850 a year, or $2,238 a month, at the same 3% rate after inflation.
Lucy could take her CPP benefits, $12,780 a year with a 14.4% penalty for starting benefits at 63, to obtain $10,940 a year, or $911 a month. Her pre-tax monthly income would be $3,150 before tax. Her tax rate would be about 14% after excluding TFSA income from tax, leaving her with about $2,700 a month in 2015 dollars.
At 67, she could add OSA at $6,765 a year, or $564 a month, to make total income $3,714 before tax, or $3,268 after 12% average income tax based on age and pension income credits. That would cover her allocations, currently $5,245, but due to fall to $2,989 a month after elimination of the Arizona condo and its interest costs and condo fees, RRSP savings and her own home mortgage.
“Lucy should be able to have a comfortable retirement because of her modest lifestyle,” Ms. Nalbantoglu says. “The Arizona condo is a drag on her ability to save. Bottom line – it's really about having money to spend. Lucy will need liquidity in retirement. Selling the condo and ending the cash drain is the conservative and prudent thing to do.”