Come August, Melanie will have paid off the mortgage on her Alberta house, freeing up $1,027 a month. She is 52. "I'm not sure what to do with all that available cash," Melanie writes in an e-mail.
Melanie has been in the same job for 20 years and is earning nearly $72,000 a year. She has a defined-benefit pension plan that will pay her about $30,000 a year at the age of 59, partly indexed to inflation. Her goal is to retire at 59 with the same lifestyle that she currently has, but with the ability to to do some additional travelling.
When she retires from her job, Melanie plans to move to British Columbia's Okanagan Valley. She wonders if she should buy a place now and rent it out until she is ready to make the move. Or should she stash the extra cash in her registered retirement savings plan?
We asked Aaron Hector, a fee-only financial planner at Doherty & Bryant Financial Strategists in Calgary, to look at Melanie's situation. Mr. Hector holds the certified financial planner (CFP) designation.
What the expert says
Melanie's pension is indexed at 60 per cent of the provincial cost of living index. She has available RRSP contribution room of $23,436 and available tax-free savings account room of $9,900.
Even though Melanie plans to move to B.C., Mr. Hector cautions her against taking on a second property. Buying more real estate "would really leave her exposed if Canada experienced a housing correction," the planner says.
As well, "being a long-distance landlord would require her to hire a property manager and this would eat into her profit margin," he adds. If she had trouble finding tenants, the second property could start to be a drain on her monthly finances.
"Also, as a rental property, any increase in value over the next seven years would not be sheltered under the principal-residence exemption," Mr. Hector says. "Seven years is also a long time, so I would suggest waiting until she is closer to that date to get serious about a property purchase in B.C. because her priorities and goals could change."
Once Melanie has paid off her mortgage, the planner suggests she focus on making additional contributions to her RRSP. She is currently in Alberta's middle tax bracket with a marginal tax rate of 30.5 per cent. When she retires, she will be in a lower tax bracket (a marginal rate of 20 per cent) because her pension income will form the bulk of her immediate post-retirement income, the planner says.
The 20-per-cent rate assumes she will be living in B.C., where her marginal tax rate will be 5 percentage points lower than if she stays in Alberta.
Melanie is currently carrying $12,254 of debt on a line of credit at a 3.2-per-cent interest rate. She could restructure it to make the interest tax-deductible, lowering her after-tax cost to 2.2 per cent. She would take the money in her non-registered portfolio and pay the line of credit off completely. Then she would borrow the same amount from the line of credit and repurchase her original non-registered investments. It is worth noting that if she hadn't had her non-registered money in mind for other shorter-term goals, including a trip to Asia, then she could have used it to top up her RRSP or to pay off her line of credit entirely.
"She ends up in the exact same position as she started, but now there would be a paper trail for the Canada Revenue Agency to show that the debt is being used for investment purposes," the planner says. At 2.2-per-cent interest, the cost to carry the debt is low and allows her to focus on her RRSP savings in the near term. When her RRSP and TFSA are topped up and her debt is ultimately cleared away, Melanie could start to accumulate additional non-registered savings.
Melanie had been planning on taking Canada Pension Plan benefits at the age of 60. This would reduce her entitlement by 36 per cent. (If you take CPP benefits early, they will be reduced by 0.6 per cent for each month you receive them before the age of 65.) Drawing money out of her RRSP early in retirement at low tax rates, in contrast, would allow her to postpone taking her CPP until later in life, Mr. Hector says.
Taking CPP benefits at the age of 65 rather than 60 makes sense for Melanie, he says. First, she doesn't need to rely on CPP to fund her lifestyle. Second, when asked about her health and her family's longevity, she said: "My family is generally healthy and long-living and I try to eat my vegetables and keep active." Delaying her CPP, and potentially her Old Age Security, will provide her with enhanced income and financial security later on in life, the planner says.
When Melanie retires, she will no longer be making pension and RRSP contributions. With her mortgage paid off, her monthly outlays will fall to $2,115. "Her after-tax pension alone will cover that," Mr. Hector says. She can use her RRSP, TFSA, CPP and OAS to fund the extras, such as travel and vehicle replacements.
Melanie's planned move to the Okanagan will come with significant costs even if she does not buy a more expensive home. Real estate and closing fees could surpass $12,000. Then there would be costs to pack, move and unpack her belongings. She would also have to pay B.C.'s property transfer tax. On the purchase of a $275,000 home, for example, the tax would be $3,500.
Instead, she could consider finding employment in the Okanagan prior to moving. If she is moving to a new job, the above expenses likely would be deductible against her future income. "A semi-retirement with a serious tax-savings kick may be something that Melanie finds attractive for the first year or two of her life in B.C."
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The Person: Melanie, 52
The Problem: What to do with the extra cash flow she will have when she pays off her mortgage. Should she use it to buy a rental property in the Okanagan, or to contribute more to her RRSP and TFSA?
The Plan: Pay off the mortgage and restructure the line-of-credit debt so it is tax-deductible. Keep life simple and skip being a long-distance landlord. Instead, direct surplus cash flow to RRSP and then TFSA.
The Payoff: A tax-efficient road map to retirement
Monthly Net Income: $4,690
Assets: House $280,000; non-registered investments $15,000, RRSP $133,000; TFSA $53,000; estimated present value of defined-benefit pension plan $285,000. Total: $766,000
Monthly Distributions: Mortgage $1,027; property taxes $255; home insurance $100; utilities $175; maintenance, garden $60; transportation, fuel, car insurance, maintenance $155; groceries $275; clothing and dry cleaning $95; line of credit and credit card payments $303; gifts and charitable $75; phone, Internet, cable $141; vacation $150; entertainment, dining out, alcohol, hobbies, personal care $175; pet expenses $125; health-care expenses $30; RRSP and TFSA contributions $367; pension plan contributions $1,157. Total: $4,665
Liabilities: Mortgage $9,293; line of credit $12,254; credit card $1,121. Total: $22,668