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What’s the better option when it comes to saving for retirement: real estate or the markets? It’s a question Joe* and Alice are grappling with as they prepare to purchase their next home.
Right now, most of their money is tied up in real estate. Their principal residence is outside Vancouver and valued at around $1.15 million. The variable-rate mortgage of $100,000 should be paid off in three years. They also own a rental property, valued at about $1.35 million, that brings in $5,200 a month before expenses, but only generates $2,400 in annual profits. The mortgage on this property matures in 19 years and costs $4,100 each month.
The couple has a young son and want to move into the city to be closer to family. Their initial thought is to turn their current home into a rental and use a good chunk of their savings ($207,000 in guaranteed investment certificates) to fund the down payment. But they aren’t sure if this is the best way forward since Joe, 42, wants to retire in about 10 years from his career in logistics.
“That’s the dream,” he said. “I’m just not sure how realistic it is.”
Joe’s annual income is $120,000 and he has a defined-benefit pension plan that should pay $5,077 a month before tax if he retires at age 62. Retiring at 52 would cut the pension income in half. Alice, 43, is a co-ordinator at a non-profit and plans to work until she’s 65. She currently earns about $65,000 a year before tax and doesn’t have a work pension.
The family’s monthly expenses are a bit more than $14,000. This includes $2,900 for the mortgage on their principal residence and about $2,000 in 20-year term life insurance premiums on policies worth $2.3 million ($1.5 million for Joe; $800,000 for Alice).
Outside the GICs, the couple have about $311,000 in retirement savings that are largely invested for growth, but it’s self-directed and they admit they don’t have a real plan They currently invest $1,700 a month in their registered retirement savings plans (RRSPs) and tax-free savings account (TFSAs), and $208 a month into a registered education savings plan (RESP).
They want to know if it would be better to sell their principal residence to pay for a new home in Vancouver and forego the additional rental income. The rental property is jointly owned and they split the income. Should they transfer the title to Alice, who earns significantly less than Joe, as a tax-planning measure? Joe wants to know how using their savings to add to their real estate holdings will impact his potential early retirement.
What the experts say
Retiring at 52 will likely have to remain Joe’s dream regardless of how the couple choose to fund it, according to fee-for-service financial planner, tax accountant and blogger Ed Rempel. He said to maintain their current lifestyle in retirement, they would need to generate a minimum of $100,000, and ideally $120,000, a year in today’s dollars.
Based on their current retirement investments and investing $1,700 per month for retirement, they should have about $1.2 million in 10 years. They probably need $3.3 million to comfortably retire.
“They are 64 per cent behind their goal and will need to sell one or ideally both properties,” Rempel said. “Ed’s Rule of Thumb for Rental Properties is that it’s best to sell when the mortgage is down to half the value of the property. Real estate grows far slower than the stock market, but the leverage factor of a large mortgage can make it a good investment. Their rental mortgage is just under half the value now, so selling to invest in equities is a good benefit for them.”
They are 64 per cent behind their goal and will need to sell one or ideally both properties
He offers two potential scenarios.
If they sell their home to buy a new home in Vancouver and sell their rental now to invest $600,000, they can retire on $100,000 per year in today’s dollars at age 55.
If they sell their home to buy a new home in Vancouver and sell their rental at retirement to invest $1 million, they can retire on $100,000 per year in today’s dollars at age 60.
Allan Small, a senior investment adviser at iA Private Wealth, presents another option. They could keep the rental home, sell their current home and use a percentage of the sale price, say 50 per cent, for the down payment and use the rest to invest, leaving their current savings in place
“This will also help them diversify their portfolio,” he said. “They will have a rental plus more investments to convert to income in retirement.”
If they do keep the rental, there is no benefit to transferring the title to Alice.
“Tax ownership and legal ownership can be different,” Rempel said. “For tax purposes, changing the title alone does not change who claims the net rent income. They would need to actually sell the property entirely to Alice. This would trigger capital gains tax and increase their mortgage.”
Small said there is definite room for improvement when it comes to the couple’s investments.
“I question having almost half their investable assets in GICs. Even though they are paying four per cent, inflation is 4.3 per cent. They aren’t growing their wealth. They can do a lot more with that money,” he said. “For example, if they want to generate income, they could buy dividend-paying investments.”
But both Small and Rempel agree with the couple’s focus on growth-oriented investments.
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“Investing in equities is the most reliable allocation for long-term returns after inflation — more reliable than having some in fixed income, based on long-term, inflation-adjusted studies of actual returns,” Rempel said. “The most effective investing is either broad-based global and U.S. equity indexes, such as S&P 500 or MSCI World (with a minimum in Canada) or finding top investors to invest for you.”
* Names have been changed to protect their identities.