Wealth on paper doesn’t necessary mean carefree living. In Vancouver, a retired couple we’ll call Roland, 69, and April, 67, are in the curious position of being real estate millionaires but struggling to remain middle class in their way of life. The reason is the soaring B.C. property market, which has raised the estimated prices of their 1,800 square-foot city house and 900-square-foot country cottage, where their family retreats, to a total of $1,550,000. They have been pushed by circumstance to live up to their level of assets, but they are going broke trying to do it on after-tax income of $4,247 a month. They need to make fundamental decisions on what assets they can afford to keep and what has to go. Their current monthly pretax income of $4,526 is composed of April’s $1,388 work pension, two Old Age Security pensions of $534 each, two Canada Pension Plan benefits that total $1,570 and Roland’s $500 monthly income from odd jobs. Their financial assets are $210,000.
The problem is that after tax on income over their credits and deductions, they have $4,247 to spend each month. But their monthly expenses of $5,184 leave them with a deficit of $937 a month or $11,244 a year. They are spending 22% more than their take-home income. The deficit has to be eliminated. B.C. homeowners can defer property taxes on one residence, but that’s only a Band-Aid fix. Even with deferral, they would still be running a deficit. Their only big bills, other than $500 to their travel fund, are for property taxes, light, heat, water, repairs and insurance for the two homes, for a total of about $1,800 a month. Housing is consuming them and their income.
“We are land-rich and cash-poor,” Roland says. “We are comfortable with our lives, but we recognize that we have to bring our income into line with our expenses. We also want to help our kids, which means that we will have to turn some of our land assets into cash.”
Family Finance asked Derek Moran, a registered financial planner and head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with the couple. “This situation calls for an urgent resolution. The couple is bleeding money it doesn’t have.”
There are several options, Mr. Moran says. They can make up the shortfall by taking more money from their retirement savings. To cover their deficit, they would have to take $14,055 out each year and pay taxes at a 20% rate, leaving them with $11,244 extra per year. That would cover the deficit. They could sustain that rate of withdrawal for 20 years, assuming their financial assets continue to grow at 3% over the rate of inflation. Then, in their mid-80s, they would be dependent on Old Age Security, the Canada Pension Plan and April’s work pension.
Alternatively, they could sell their $53,000 portfolio of non-registered stocks, pay off their car loan and line of credit, a total debt of $47,000, which together costs them $650 a month to service, or take the major step of selling either their house or their cottage
They spend most of their time in the city, so the vacation property is an appropriate candidate for sale. If they were to realize $525,000 after selling costs, they would cut expenses by perhaps $600 a month. If they obtained a 5% return, which is $26,250 a year, then after tax, they would have about $21,000 to spend. Their total return from saving and investment would be enhanced by the approximately $600 a month, or 7,200 a year, they would save on taxes and upkeep costs by not owning the cottage. Their annual deficit of $11,244 would be covered and they would have more money to spend.
They could still spend time with their three grown children and their families in a rented cottage. Moreover, they would be able to rationalize their portfolio of assets in which real estate amounts to 76%. In a potentially overvalued property market, cutting exposure to property makes sense, the planner says.
The problem with selling the cottage is the emotional baggage it carries. They regard it as an anchor for their children, the place of refuge and return. Renting to them is not the same as owning. They would prefer to sell their Vancouver house. They figure they could get a good price.
Sale of the city house could bring perhaps $950,000 after selling costs. They would be able to cover their $47,000 of debts quite easily. The remaining money, say $900,000, could easily generate $45,000 at a 5% return. That would be at least $3,750 a month before tax and perhaps $3,000 after 20% income tax. The income would cover the deficit, pay the rent on a good apartment and leave some cash for other things. This is an alternative solution for the couple, Mr. Moran says.
Cutting More Costs
There are other potential solutions. They could put their life policies on a premium holiday, which would mean that premiums would be paid from the policy itself. That would save them $173 a month. They could eliminate travel spending, saving $500 a month. They could cut gifts to their children by $100 a month and trim $400 a month from groceries and restaurants. Those cuts would take $1,173 out of their monthly deficit. But they would still be $391 over budget. The cuts would mean a less enjoyable retirement. In comparison, selling one property is the lesser sacrifice, Mr. Moran suggests.
“They have to confront their emotions and do what is financially right,” he says. “They must sell one property. If they don’t, the nostalgia they have for their cottage and the affection they have for their city house will be more than matched by the regret they will have when they are broke.”
(C) 2012 Financial Post, Used by Permission