To Sell or Not to Sell - Pricey Home Key to the Future

Academic eyes summer travel but the sacrifice is a million-dollar residence

ANDREW ALLENTUCK

Globe and Mail Update

In Victoria, a 53-year old woman we'll call Susan has combined an academic career with a bit of enterprise as a landlord by renting out an apartment in her home. Her total income for 2005, $79,151, plus a house she estimates is worth $1-million, make her prosperous on paper. She pays her own expenses plus those of a teenager soon to enter university. She also has an older child in her mid-twenties who has left home and is finishing an advanced degree while living in another city. Susan is able to maintain a pleasant way of life. Yet she worries that she cannot live up to her means.

"Can I afford to stay in the house?" she asks, noting that she bought it in 1976 for $46,000. "I want to stay because this is a home more than an investment. I am house rich for the moment, but what sort of cash flow will I have if I keep it into my retirement?"

What our expert says:

Facelift asked Derek Moran, a registered financial planner who heads the Kelowna, B.C., office of fee-only planning firm Macdonald Shymko & Co. in Vancouver, to work with Susan to determine how feasible it is for her to maintain her way of life.

"The core of her issue is wrapped around her home, in a spectacular area of Victoria," Mr. Moran says. Although far from new, the house would fetch more than $1-million these days. That seems like a lot, but the high price comes with annual property taxes of $5,400. Add that to Susan's cost of raising her 17-year-old and her annual income no longer seems so ample. Indeed, there are tough choices to be made.

The house, as it exists, is a substantial drain on Susan's income. House utilities, maintenance expenses and insurance that totals $670 a month, on top of $450 a month for property taxes, cost 20 per cent of her net earned income of $5,650 a month. Child support from her former husband contributes $2,000 to her monthly income. But support will end in mid-2007 once her teenager moves out and begins university. That will be a major cut in her total income.

The first thing Susan can do to improve her finances is to pay off her $6,000 car loan, which bears interest at 6.1 per cent a year, out of her $28,000 cash, Mr. Moran notes. This transaction will produce a return equivalent to a pretax yield of 8.5 per cent, he explains. It is a low-risk way to boost income, he says.

Susan's retirement will be based on her assets. She has a defined contribution pension through her employer worth $93,580. She has added $1,950 a year to the plan, and her employer adds $4,862 for a total of $6,812 every year. By age 60, with an assumed 6-per-cent annual return, less 3-per-cent inflation, the pension will have a value of $168,806, Mr. Moran says.

She could begin withdrawals without penalty in 2008. Thus her plan to retire when she reaches age 60 will not reduce her benefits. Conservatively assuming that Susan will live to 87, which is five years beyond her actuarial expectancy of 82 years, the money will support an indexed annual payment of $8,942 for the 27-year period after her planned retirement, Mr. Moran says.

On top of her employment pension, Susan will be eligible for $15,900 a year as her share of her ex-husband's pension. There is also a supplementary bridge of $3,600 a year payable to age 65 through her ex-husband's defined benefit pension plan.

Susan also has $110,000 in a registered retirement savings plan. She adds $4,800 a year to it. By age 60, assuming a real return of 3 per cent, the RRSP will have a total value of $182,640 in 2006 dollars, Mr. Moran says. Based on an age 87 life expectancy, the money will provide an annual index cash flow of $9,675.

At age 60, Susan can apply to receive Canada Pension Plan benefits. Based on her work experience, she should receive 73 per cent of the maximum payout of $10,135 in 2006 dollars, Mr. Moran says. Early application will reduce payouts by 0.5 per cent for every month prior to her 65th birthday, resulting in a payment of $5,189 in 2006 dollars, Mr. Moran notes. She may also be eligible for credits from her ex-husband, he adds.

Before age 65, Susan's annual income will be $51,106, consisting of $15,900 of her husband's indexed pension, a $3,600 pension bridge, $9,675 in RRSP withdrawals, $8,942 from her defined contribution pension, $5,189 from the Canada Pension Plan and $7,800 in rental income.

At age 65, the bridge pension will be gone and she will qualify for Old Age Security Payments that are currently $5,816 a year. At this point, her income will total $53,322 a year.

Her income is sufficient to maintain her house for times when her children visit. But it is clearly not sufficient to pay for the house and the maintenance it will require, and the extensive travel she anticipates.

But financing months on the beach and extensive travel to see her children would strain her budget, Mr. Moran insists. She could, as she has in the past, rent out her house, while she is away, for $2,000 a month, but that might not cover all of her costs under the palms.

"Susan needs to make a choice," the planner says. "She can keep the house and go without six-month stretches in the tropics or sell her house, capture a tax-free capital gain on her principal residence, which will be almost $1-million at current prices, and move into a place that costs perhaps $500,000." She would then add the $500,000 gain to her capital to provide supplementary income. If that sum yielded 3-per-cent real income a year, she would have a stream of $26,487 to spend until age 87. That would boost her total income from the low $50,000 level, as indicated, to almost $80,000 a year, Mr. Moran estimates. It would give her the choices she wants and still have a substantial home, although perhaps not as graceful a residence as she now enjoys, he says.

There are some expenses Susan need not incur. She has group insurance through her employment which covers two times her annual salary. After she retires, however, there should not be a need for substantial insurance. Her assets, which currently include a $1-million entirely paid for house, would yield at least $500,000 for each daughter. Her other financial assets would also be divisible and add to her estate, Mr. Moran notes.

"Susan is emotionally attached to her house," Mr. Moran explains. "But she needs to deal with it in financial terms and to balance the value of the life she has had in the house with the future she wants to have. It is a question of balancing the past with the future."

"I think it is great to have this plan and to know what my retirement income will be," Susan says. "It has made me realize how hard it would be to leave the house. But I want to keep it. If I have to, I will spend less time away from Victoria in the winter."

Client situation

Susan, 53, lives in Victoria with her teenaged daughter.

Net monthly income: $3,000 from employment; $2,000 child support (ends in 2007); $650 suite rental.

Total: $5,650.

Assets: House, $1-million; car, $12,000; RRSP, $110,000; pension, $93,850; personal property, $100,000; cash, $28,000.

Monthly expenses: House taxes, $450; house insurance, $50; gasoline and car maintenance, $100; auto insurance, $100; utilities and maintenance, $620; food and dining out, $700; health expense, $70; clothing, $100; travel, $400; books and pets, $100; charity, $20; RRSP, $400; savings, $2,540.

Total: $5,650.

Liabilities: Car loan, $6,000.
Quote: "Susan needs to make a choice. She can keep the house and go without six-month stretches in the tropics or sell her house, capture a tax-free capital gain on her principal residence, which will be almost $1-million at current prices, and move into a place that costs perhaps $500,000."

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