Can Tom and Marie travel the world with their line of credit for 10 years without having financial problems?
Wisdom dictates that you pay off your mortgage before you retire from work, and for most people, that’s the safe thing to do. Tom and Marie rather want to “spend” their house.
“We want to allow ourselves to splurge for the first 10 years as long as good health allows, and then slow down a bit for the following years,” Tom wrote in an email.
“Popular wisdom suggests that it’s not a good idea to use debt to fund retirement expenses,” Tom writes, “but I’m not sure I understand the problem! Newly retired, Marie and Tom, both 60, have defined benefit pension plans, $ 1.4 million in investment assets, and a mortgage-free home in Quebec valued at. $ 1.8 million.
They want to travel a lot over the next 10 years or more, but they are not particularly keen on selling their home. Their retirement spending goal is $ 200,000 per year for the first few years, then $ 150,000 thereafter.
“Initially, without touching our RRSPs and TFSAs, we calculate that our [defined benefit pension] the income will be $ 53,460 per year, ”writes Tom. They are entitled to receive benefits from the Quebec Pension Plan at age 65. To meet their spending goal, they plan to use the $ 700,000 they have in short-term, easy-to-cash investments. “This will cover our shortfall for the first five years,” Tom writes. “Then we’ll use our line of credit instead of selling the house. They wisely set up the home equity line of credit – secured by a mortgage – before they retired. “Our reasoning is that the value of the house will increase by 5% per year tax free, much faster than the interest we will have to pay on the debt – 2.5% on the gradually growing balance,” he adds. -he.
“Once we’re ready to sell, we’ll pay off the line of credit and buy a condo for our retirement with the money left over.” If the interest on the loan exceeds the increase in the value of the property, “we’ll change plans and sell.” Is this plan reasonable? they ask. “What’s the most fiscally efficient way to go about it?” “
We asked Warren MacKenzie, CFO at Optimize Wealth Management in Toronto, to review Tom and Marie’s situation.
What the expert says
The plan is indeed reasonable, says MacKenzie. “They would have their house for another ten years and any capital appreciation they might enjoy will be tax free.” If the house appreciates at the rate they are hoping for, Tom and Mary should have made nearly 10% of a private debt instrument to produce the same after-tax return, according to the planner.
Part of the reason this plan works for them is that they don’t mind leaving a big estate for their two grown children, Mr. MacKenzie says. “They have already helped their children pay for their education and taught them to be self-confident. They are not looking for more financial help.
Marie and Tom are better off than the average Canadian because they have indexed pension plans that, combined with government benefits, their registered retirement savings plans and the eventual proceeds from the sale of their home, will be more than enough. to live, according to the planner. . They’re going to dip into their capital, but that doesn’t matter because they don’t care about leaving an estate. “By age 100, they will have used up most of their savings, but they will still have nice pensions,” he says. In addition, they have the flexibility and the willingness to change course if necessary.
Mary and Tom’s basic plan “is to spend like their wealth is in the bank when in fact it’s tied to the equity in their home,” the planner explains. When they run out of cash and liquid investments, they’ll borrow against their home equity line of credit. If interest rates rise or real estate prices languish, they will shift into high gear and sell the property. Because they expect to live to age 90, he suggests they consider postponing government benefits to age 70.
“With many trips, by the end of 2030 they will have spent about $ 2 million on lifestyle and income taxes,” MacKenzie said. “Of that total, about $ 500,000 will come from their pensions, $ 300,000 from Tom’s RRSP, their $ 700,000 in cash equivalents and about $ 500,000 from their line of credit. By 2032, when they both receive government benefits in addition to their working pensions, their total pension income will be around $ 115,000 per year (adjusted for inflation) and their net worth, excluding the estimated value of their pensions, will be around $ 2.4 -million, says the planner.
Its forecast assumes an average annual rate of return on their investments of 4% and an inflation rate of 2%.
For tax purposes, they should plan to split their pension income. “However, since Mary has a higher defined benefit pension and Tom has a larger RRSP, income splitting will only be a marginal benefit,” said Mr. MacKenzie. During the first 10 years of his retirement, Tom will have low taxable income, so he should turn part of his RRSP into a registered retirement income fund. He would withdraw enough income from the RRIF to increase his total taxable income high enough for him to take full advantage of the low federal and provincial tax rates that apply to the first $ 44,500 of taxable income, according to the planner.
“If he doesn’t, in the future, when he receives government benefits, he will be in a higher tax bracket because he will have a larger RRIF withdrawal,” he adds. . It may also mean that some of his Old Age Security will be clawed back, he adds.
Tom and Marie’s combined investments total approximately $ 1.43 million. Of this total, approximately $ 850,000 is in cash and liquid investments. Most of their RRSPs and tax-free savings accounts are invested in equity-based exchange-traded funds. “Given that the stock markets are approaching all-time highs and most cash investments will be required over the next few years, it makes sense to have around 60% of the entire portfolio in short-term investments.” said Mr. MacKenzie.
At some point in the future, when they reduce their travel and their cash account has been spent, they should consider moving their registered accounts to a more balanced and diversified portfolio.
Warning: what if they change their mind and want to keep their house? Let’s say they’ve built up a $ 500,000 line of credit – about 25% of the value of their home in about 10 years – but they don’t have the cash to pay it off. Their line of credit is backed by a mortgage, so they could presumably turn it into a mortgage. The interest just on a $ 500,000 mortgage at 5% amortized over 25 years would be about $ 25,000 per year, according to the planner. Principal payments would increase this amount to over $ 35,000 per year. Meanwhile, their income from indexed pensions and government benefits would have reached about $ 115,000 before tax. Homeowners who use this strategy should therefore ensure that they understand the potential risks.
People: Tom and Marie, both 60 years old
The problem: Can they travel the world with their line of credit for ten years without encountering financial problems?
The plan: Go ahead and splurge. Their plan works as long as the price of real estate increases faster than the interest rate on the line of credit.
The reward : Hopefully an enjoyable decade or so – and a comfortable retirement
Monthly net income: As required
Assets: $ 35,955 in cash; liquid investments $ 700,000; his RRSP $ 186,025; his RRSP $ 421,075; his TFSA $ 62,840; his TFSA $ 22,635; commuted value of their annuities $ 1.2 million; residence $ 1,824,000. Total: $ 4.45 million
Monthly expenses: Property tax $ 775; home insurance $ 265; heating, electricity $ 550; maintenance, garden $ 335; car rental $ 415; other transportation $ 350; groceries $ 2,200; clothing $ 1,000; gifts, charity $ 600; travel $ 5,835; personal care $ 125; dinner at the restaurant $ 915; entertainment $ 400; sports, hobbies $ 250; health care $ 85; telephone, television, internet $ 210. Total: $ 14,310
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Some details can be changed to protect the privacy of those profiled.
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