A couple we'll call Hilary and Peter live on a small yacht they have moored on the B.C. coast. Though they cruise to warmer places in winter, their boat is home. However, they envy landlubbers who have participated in the extraordinary land price increases in British Columbia. Peter, 52, a corporate executive, and Hilary, 45, a government official, ask if they still have time to get in on the boom.
"We feel we have missed out on the real estate opportunities in B.C.," Hilary explains. "We are concerned about our savings yet wonder if we might buy a house as a principal residence or perhaps a condo in Mexico for retirement. We might buy the house just to rent it out. We want a stake in the market."
Hilary and Peter have a lot of choices. Their gross annual income, $240,000, has allowed them to have the boat, worth an estimated $150,000, a cabin in the B.C. Interior with an estimated value of $330,000, and a couple of sport utility vehicles. They have $477,500 in registered retirement savings plans, not so much from savings as from a pension rollover. But the question they pose is fundamental. Should they put down roots and make a commitment to life on the land with its attendant opportunities for capital gains or losses, real estate taxes and all the costs of ownership?
What our expert says:
Facelift asked Derek Moran, president of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Hilary and Peter in order to help them sort out their choices.
His analysis points out that they have lived very much for the present, given relatively little attention to the future, and now consider adding debt -- and risk -- in order to catch up to the homeowners they envy.
"The couple has spent relatively lavishly on living well and not been very diligent in their savings," he explains. The question of whether to stay moored on the water or to go ashore -- perhaps borrowing to buy a house as a rental property that could also generate capital gains -- requires financial analysis, Mr. Moran adds. He notes that a home's value should be a function of the rent it can command. However, today's high house prices have driven rental yields down, making the purchase of rental properties unattractive, he explains.
Cost of purchase is another issue. Hilary and Peter, in spite of their substantial incomes, have relatively little free cash. There is also the risk that the Lower Mainland market may cool off or even retract some of its gains. That would erode the couple's net worth. Given the uncertainty of market prices, purchase of a house with borrowed funds would be far too speculative, the planner says.
Hilary and Peter could cut their financial risks by selling their boat and their cabin and use the potential proceeds of $480,000 to buy a house or at least make a substantial payment on it. But even this strategy has a flaw, for the couple has $106,000 in debt, including an $81,000 mortgage on their cabin. To eliminate their existing debt in full by the time Peter reaches age 60, when he would consider retiring, they would have to increase their present interest payments of about $750 a month to $1,270 a month, assuming an average 6 per cent rate of interest on their mortgage, lines of credit and credit card debt. They can do it with their present cash flow, the planner says.
Buying into the B.C. land frenzy is not the couple's top priority. They need to plan for their retirement with secure rather than insecure assets, Mr. Moran says. Planning is, however, a complex exercise, for the couple's plans are uncertain.
Hilary's government pension will give her 2 per cent of the average of her best five years earnings. If she maintains her $90,000 annual wage until age 55, that would give her $16,200 less a 15-per-cent penalty or $13,770 a year indexed to the cost of living. To avoid the 15-per-cent penalty, she would have to work to age 60.
In addition to her company pension, the couple can expect to receive substantial Canada Pension Plan benefits as well as Old Age Security. Peter will receive no company pension.
The couple's retirement can follow one of the two following scenarios, the planner says.
In the first case, they are assumed to work to Hilary's age 55 when Peter will be 62. They would have her reduced pension of $13,770. Assuming their combined portfolios grow at a 3-per-cent rate after inflation, with $20,900 annual contributions to a total of $845,514 in 2007 dollars, they could draw $41,470 a year until her age 87, which is five years beyond her life expectancy. CPP would start for Peter right away at an assumed rate of $10,354 less a penalty of 18 per cent that amounts to 36 months times 0.5 per cent a month for each month prior to age 65 that benefits begin. Hilary would receive 80 per cent of maximum CPP credits, which would also be reduced by the same amount for each month prior to age 65 at which she begins to receive benefits. OAS would be $5,903 for each starting at age 65.
Therefore, when Hilary is 55 and Peter is 62, the couple would have total income of $63,739 in 2007 dollars composed of the $13,770 pension, $41,470 from their investments, and $8,499 from Peter's CPP. When Hilary reaches 60, she would receive $5,804 a year from CPP at 80 per cent of maximum benefits less a reduction of 30 per cent for early encashment.
When each partner is 65, OAS would add $5,903 in 2007 dollars to the individual's income.
In the second scenario, Peter will work to age 65 and Hilary to age 60. His CPP will be $10,365 in 2007 dollars plus $5,903 from OAS, also in 2007 dollars. He could draw on retirement savings, but would not need to do so, for the couple would have Hilary's income for two more years.
Retiring at age 60, Hilary will have her estimated pension of $25,200 in 2007 dollars and her CPP, which by then should be at 90 per cent of maximum benefits less a 30-per-cent penalty for early application or $6,530 a year, the planner estimates.
Once retired, the couple could withdraw $56,070 a year from their registered savings over the 27-year period projected until Hilary's death. With that extra time to grow, the portfolio would have risen in value to $1,027,640 by her age 60, again in 2007 dollars.
At age 65, Hilary will receive full OAS benefits of $5,903 a year in 2007 dollars. At this point, family income will be $109,973 in 2007 dollars before tax. That sum is about what the couple now has to spend less retirement savings they will no longer make and service charges on debts that will have been paid off. The OAS clawback, which is triggered when individual income reaches $62,144, will not have been triggered at any stage, particularly if the couple has used income splitting for tax purposes, Mr. Moran notes.
"The bad news is that this couple has to make some decisions about how they want to live," Mr. Moran says. "They can buy property and add to their debts. Or they can reduce debt, invest in a diversified portfolio of financial assets with what is likely to be lower risk than plunging late into the B.C. real estate market, and build a secure retirement. They have to focus on retirement rather than speculation. The irony that living on a yacht has in some ways been cheaper than living on land has become part of their retirement planning dilemma."
"My intuition is to do as Mr. Moran says," Peter explains. "We would sell the boat but not the cabin -- that's where we want to spend half the year once we retire. And we want to retire early, that's when I reach 60, even if that would mean a reduction in income well below our current take-home pay."
Hilary, 45, and Peter, 52, live in British Columbia.
Net Monthly Income
Yacht $150,000, cabin $330,000, SUVs $14,500, RRSPs $477,500, taxable $11,000, stocks $3,000, personal $35,000, cash $10,000.
Mortgage $650, loan interest $150, property taxes and insurance $216, boat maintenance and slip $600, cabin repairs $3,600, utilities $200, food and restaurants $900, entertainment $250, clothing $200, RRSPs $1,740, car fuel $200, vacations $1,250, gym $250, car and boat insurance $375, charity and gifts $500, storage locker $140, miscellaneous $400, savings, $527.
Mortgage $81,000, lines of credit $21,000, credit cards $4,000.
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