Couple Living the Good Life Must Learn to Plan Ahead


Andrew Allentuck

British Columbia's Gulf Islands lured a couple we will call Frank, 50, and Luisa, 49, dual U.S. and Canadian citizens, to getting in touch with nature, living at their own pace and raising their children, now ages 11 and 14, away from the rat race. Frank is a carpenter, Luisa a management services subcontractor in an independent business. Spiritually, they have thrived, though their financial lives are another story.

In choosing life away from cities and commerce, they accepted reduced net incomes that currently total $4,600 plus rental income of $1,200 per month. Frank has built two rental cottages that have a present value of $350,000. They have $8,000 in their children's Registered Education Savings Plan and $11,000 in non-registered mutual funds. Add in the estimated $350,000 market value of their house and their total capital is $719,000. Their liabilities, though, are modest — a $95,000 mortgage for all the properties and $25,000 on a line of credit.

They have no problem living within their present means, but they wonder how they will be able to finance their children's post-secondary education and their own eventual retirement, taking time out to travel and perhaps to move to California, where Frank was born.

The problem

"We have no retirement savings," Luisa explains. "We will receive no company benefits at retirement. We have not contributed enough to the kids' RESPs. We need to know where we stand financially and where we ought to be going."

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Frank and Luisa to develop a plan for their children's education and for their own future.

"Frank and Luisa are happy with their lives," Mr. Moran says. "But they are married to it. Their assets are all in their real estate. They have almost no portable assets."

The main issue to be addressed is the profitability of the rental property. All debt is allocated to the rentals, so they have $230,000 of equity in the investment. The rental income is $1,200 per month less taxes of $120 and mortgage interest of $400 per month. That leaves net income before repairs of $680 per month or $8,160 per year. That's a yield on equity of 3.55%, which is far too low for a property that has a mortgage backing a third of its value, the planner says. They could sell the rental properties, use the net proceeds of $230,000 less any selling costs, and invest in a mix that would yield, say, 6% or $13,800 per year. That would be what the rentals provide but would allow elimination of the mortgage. They would then gain use of the $1,200 per month or $14,400 per year they paid on their mortgage. The cash could pay for contributions to their children's RESPs and their own retirement funds.

The Five-Year Plan

Year 1 (2011) There is sufficient savings capacity now to put a total of $2,500 each year to each child's RESP. That will qualify the accounts for the maximum Canada Education Savings Grant of the lesser of 20% of contributions, or $500. Even if the parents had to borrow the money at, say, 4% per year, it would make sense, Mr. Moran says.

If the two children's RESPs are combined, then the parents have nine years for contributions to be matched by the CESG. If maximum contributions are made, the current balance of $8,000 will grow until each child reaches age 18 — that's six plus three or nine times $2,500 per year plus nine times $500 for a total of $35,000 plus growth. That would provide at least $17,500 for each child for post-secondary education.

Year 2 (2012) It is time to make the most of retirement options. Assuming that $5,000 per year is going to RESPs, $9,400 is left to add to the $230,000 net investment. They can transfer $11,000 of their non-registered funds into RRSPs as contributions in kind. Assuming a 3% annual rate of growth over inflation assumed to run at 3% per year, they could generate total savings of $533,160 by their respective ages of 65 and 64, Mr. Moran estimates. If savings continue to grow at this rate and were split between retirement and Luisa's age 90, a period of 26 years, the fund could support annual payments of $29,824 per year in 2011 dollars. If they are serious about moving to the United States, they should not use RRSPs, for it is easier to take money to another country if it is not registered, he cautions.

Year 3 (2013) Assuming the rental property has been sold and income has risen, then set up a spousal loan for Luisa. She can buy growing amounts of assets with her earned income and have Frank pay living expenses. It is essential that she sign a promissory note, agree to interest at the rate prescribed by the Canada Revenue Agency, currently 1% per year, and write a cheque for what she owes each year. This move will reduce the couple's total tax bill.

Year 4 (2014) Frank and Luisa have U.S. work experience and may qualify for Social Security benefits. They have discussed the possibility of moving to California. As U.S. citizens, they could begin working immediately, though finding jobs could be a challenge.

Year 5 (2015) Unprepared for retirement, Frank and Luisa should expect to work until each is 65. They need to make a decision about whether to stay in Canada and retain access to medical services and relatively low cost post-secondary education for their children or move to the United States for warmer weather and perhaps less expensive housing. If they choose the United States, they will have to sell their own residence and use that money, $350,000 less any selling costs, for a home south of the border

For the longer term

If Luisa remains in Canada to age 65, she will have the full 40 years of residence needed to qualify for maximum Old Age Security benefits, currently $6,322 per year. At his age 65, Frank will qualify for $4,583 per month of OAS benefits. The couple may also qualify for some U.S. Social Security benefits as well. U.S. benefits are under review and cannot be estimated at this time.

Assuming Frank qualifies for 75% of Canada Pension Plan benefits, currently $11,520 per year, he will receive $8,640 per year. If Luisa qualifies for 40% of maximum benefits, she will receive $4,608 per year. They can add investment proceeds of $29,824 per year for total annual retirement income of $53,977. If they pay an average tax rate of 15%, they will have $45,880 per year or $3,823 per month to spend, which exceeds their current budget less mortgage payments and kids' music and medical costs.

"Island life is the couple's utopia, but they need plan to make their lives work on a financial basis," Mr. Moran says.

(c) 2011 The Financial Post, Used by Permission