Si and Cynara have been an effective team, building a portfolio of rental properties in rural New Brunswick worth $1.2-million.
As a medical professional, Cynara earns the money (through a holding company) while Si manages the apartment properties. He is 57, she is 52. They have two children, 15 and 17, to put through university.
Their goal is to retire in eight years, when Cynara is 60, with an after-tax income of $100,000 a year. Although the rental properties generate no net income now, Si and Cynara see them as pension plans that will throw off cash flow when the mortgages are paid off in 10 or 12 years.
"They are strictly a retirement fund for us so we pay them off as fast as we can," Si writes in an e-mail. Cynara and Si have worked hard for what they have, he says. They waited until their house was paid off to have children.
"We did things like clear the land ourselves, live without finished floors, finish our home over time when we could do it ourselves," he adds. As a young man starting out, Si used to sleep at a vacant construction site, leaving before dawn and looking for work by day. "I was the only homeless guy there with a degree." Today, "we have no debt, live on a lake, drive older cars. We have no cable TV but have wonderful times with our kids and I think we have a great life so far."
They wonder whether they should use the savings built up in their holding company to buy a rental property in the city, where the children can live while they are studying and where Cynara and Si can retire eventually. Si's one reservation is his health, which might make it difficult for him to maintain the apartment buildings as the years pass.
We asked Ian Black, a portfolio manager and fee-only financial adviser at Macdonald Shymko & Co. Ltd. in Vancouver, to look at Si and Cynara's situation.
What the expert says
Si and Cynara have done a good job of organizing their affairs in order to split Cynara's income, Mr. Black says. Their use of the holding company and family trust will permit funds to be distributed to their children during university and later with little or no income tax.
Other parts of their financial picture fall short: They have no wills and not much in the way of disability insurance for Cynara. Their savings have been languishing in cash for the past two years "waiting for the double dip [recession]" Si acknowledges.
Their savings capacity is substantial – $101,600 a year, including $38,000 of principal payments on their mortgages, so they should be able to achieve their goals without too much difficulty, the planner says. They will need about $3-million in investments by the time Cynara retires, excluding their principal residence, against the $2.32-million they have already.
Even with no additional savings and a rate of return of 3.4 per cent a year on average, their investments will generate the desired $120,000 in before-tax income when they retire in eight years. If they can make 5 per cent, they will have $135,100. If their assets continue to grow by $101,600 a year (their savings capacity), and earn 5 per cent, they will enjoy income of $172,200 a year, Mr. Black calculates.
That assumes inflation of 3 per cent a year, no clawback of Old Age Security and Canada Pension Plan benefits of 75 per cent of the maximum starting at age 60 for Cynara and age 65 for Si.
As for buying a rental property in the city, Mr. Black advises against it in favour of diversifying into financial assets. In his calculations, the planner assumes Si and Cynara will draw on their principal in retirement. This is difficult to do with a rental property without selling it, he notes. By investing in marketable securities, they enhance their liquidity, making it easy to sell a portion of their investments as required.
Managing the rental properties could become an issue at some point, Mr. Black notes. Hiring an outside manager can cost up to 30 per cent of gross revenue, something Cynara and Si should consider when projecting future cash flow.
As for their investments, they hold too large a proportion in cash, Mr. Black says. They should determine their risk tolerance, come up with asset allocation targets and stick with them. If the investments they feel comfortable with are yielding 3 per cent a year or less, they "may need to do a combination of working longer, saving more or reducing their financial goals."
CLIENT SITUATION
The people
Si, 57, and Cynara, 52
The problem
Whether it makes sense to use retained earnings built up in their holding company to buy another rental property.
The plan
Diversify their holdings into marketable securities rather than adding to their real estate holdings. Develop an investment plan and stick to it.
The payoff
A comfortable and manageable retirement.
Monthly net income
$12,435 (variable).
Assets
Bank $8,000; home $400,000; RRSPs $424,000; RESP $68,000; holding company cash $370,000; rental properties $1.2-million; operating company (practice) $250,000. Total: $2.72-million.
Monthly disbursements
Property tax $200; home insurance $95; hydro $340; security $30; maintenance $270; garden $30; auto expenses $835; groceries $1,510; clothing $480; gifts $125; charity $300; vacations, travel $500; grooming $220; dining out, drinks, entertainment $330; pet $40; sports, hobbies $475; other $85; medical, dental $160; life insurance $165; telecom, TV, Internet $275; RESP $335. Total: $6,800. Surplus cash flow: $5,635.
Liabilities
Line of credit $5,000; mortgages on rental properties $535,000. Total: $540,000.
Special to The Globe and Mail
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