Margaret and Jack both own their own homes and plan to marry next year. Margaret plans to work for another four years, when Jack plans to retire at the same time.Jimmy Jeong/The Globe and Mail
When Margaret and Jack tie the knot next summer, it will be the second time around for both of them. She is 66 years old with two children, 29 and 32. He will be 71 next month and has no kids. Each has a house of their own that they plan to sell or rent out.
“I have struggled as a single mother but am now emerging into a much better situation, with independent children, a good salary with a pension and a wonderful partner,” Margaret writes in an e-mail. She recently got a raise in salary to $155,000 a year. She also gets $20,000 a year in net rental income from a suite in her home. Jack is self-employed, earning an average of $60,000 a year.
Although Margaret lives and works in British Columbia, she is a U.S. citizen.
“What might be the earliest age I could retire?” Margaret asks. Ideally, she and Jack would like to buy their “dream home” on B.C.’s Sunshine Coast. Margaret wonders if she should rent out her house for a few years. “I expect we would sell my current house when I retire, pay off the mortgage on the new house and have much more cash for our lifestyle and maybe some money for my children,” Margaret writes.
Margaret plans to work for another four years, to the age of 70. Jack would retire at the same time. Their tentative retirement spending target is $80,000 a year after tax excluding whatever mortgage payments they may have.
We asked Jeff Ryall, a chartered financial analyst and certified financial planner at Cardinal Capital Management Inc. in Winnipeg, to look at Jack and Margaret’s situation.
What the Expert Says
Margaret and Jack are considering a number of alternatives that require expertise in tax and estate planning, Mr. Ryall says. As a U.S. citizen, Margaret will also need to consult a cross-border tax specialist about the sale of her existing house. They will need separate legal advice on drawing up a prenuptial agreement, the planner says. Margaret envisages providing for the surviving spouse to stay in the new house for as long as they live, after which the estate will pass to her children.
The budget for their new home is $1.8-million. Unless they sell both their houses, they would need to borrow to close the deal, the planner notes. Margaret has a greater net worth – $2.5-million compared with Jack’s $1.4-million.
When they retire, Margaret’s annual income will be about $75,000, comprising $24,000 from her work defined-benefit (DB), $23,000 combined Canada Pension Plan and Old Age Security benefits and a $28,000 withdrawal from her registered retirement savings plan (RRSP) or registered retirement income fund (RRIF). Jack’s only income will be his Canada Pension Plan and Old Age Security benefits estimated at $18,000 a year. He has already begun collecting CPP and OAS.
“Financially, Margaret and Jack have the ability to retire in 2025,” Mr. Ryall says. Their tentative spending goal of $80,000 a year plus mortgage payments could be increased to $120,000 after tax without using the equity in their new home, he says.
The forecast assumes an asset allocation for their investments of 70-per-cent equities and 30-per-cent fixed income, a rate of return of 4.25 per cent a year and an inflation rate of 2.10 per cent.
Margaret’s DB pension is estimated at $24,000 annually, with a 60-per-cent survivor benefit; she also has a defined-contribution (DC) pension. The forecast assumes Jack lives to 95 and Margaret to 97, and that Margaret defers her CPP and OAS until the age of 70.
Given their goals and differences in net worth and income, they need to structure their joint affairs to achieve tax efficiency as well as their estate-planning goals, Mr. Ryall says.
Rather than using the net proceeds of his house sale to help buy the new house, Jack could invest the money in income-generating assets. He could then help fund the couple’s retirement lifestyle. Or he could keep the house and rent it out to generate more income.
If Margaret rents her house out while she is still working, she’ll go up to the combined federal-provincial 46.12-per-cent tax bracket, paying more taxes.
Not having the rental income in retirement would help her stay within the 28.20-per-cent tax bracket, Mr. Ryall says.
Margaret had thought she might be able to contribute to a spousal RRSP for Jack, who will be 71 next month, but that is not the case because they are not yet married or living common-law, the planner says. A taxpayer can contribute to a spousal RRSP up to Dec. 31 in the year in which the spouse turns 71.
Instead, she could split future income from her RRIF with Jack under current income-splitting rules. That would have the effect of lowering the family tax bill.
Most of Margaret’s wealth is in her existing home. She wants the new house to go to her children after both she and Jack have died. Instead of a joint purchase, she could use the proceeds of her house sale to buy the new house in her name only. She’d need a mortgage for the balance.
There would still be some division of assets in case of marriage breakdown, but “family law can acknowledge the assets they each bring into the marriage,” Mr. Ryall says. “That’s why it’s so important for them to prepare a prenup,” he adds. “This might also help Margaret achieve her goal of leaving her estate to her children. Their prenuptial agreement could be used to address this.”
Marriage will affect their ability to claim the principal-residence exemption, Mr. Ryall says. For the taxation years before and including the year of marriage, both individuals would be able to claim their respective residences as their principal residence.
After they are married, they would only be able to designate one property as a principal residence. “Selling both homes no later than the year they are married may be beneficial.”
Margaret’s house contains a basement rental suite, which may affect her ability to claim the tax-free principal-residence exemption in Canada. The Canada Revenue Agency requires the following conditions to be met to claim the exemption: Income-producing use is ancillary to the main use of the property; there have been no structural changes; and no capital cost allowance has been claimed.
“While it appears Margaret meets the above criteria, she may want to seek tax advice before disposition.” Regardless, she will need to report the capital gain on the sale of her home to the U.S. Internal Revenue Service, which could trigger a U.S. tax liability.
As for her raise in salary, Margaret should use the funds first to maximize her RRSP before she retires, Mr. Ryall says. She has $33,451 of unused contribution room. Margaret’s raise and the possibility of another pay increase in future will likely push her into the 46.12-per-cent tax bracket in B.C. for 2025.
Client Situation
The People: Margaret, 66, Jack, 70, and Margaret’s children, 29 and 32.
The Problem: When can they afford to retire and how much can they spend? Should Margaret sell or rent her current home?
The Plan: Jack could consider selling his house and using the net proceeds to invest in income-producing assets. Margaret could use the proceeds of her house sale to buy their new shared home. She could split RRIF income with Jack.
The Payoff: Everything falls into place as planned.
Monthly net income (Margaret only): $10,400.
Assets (both Jack and Margaret): Margaret’s non-registered investment $15,000; Jack’s non-registered investment $22,000; Margaret’s RRSP $300,000; Margaret’s defined-contribution pension $139,000; Margaret’s residence $1,700,000; Jack’s residence $1,800,000. Total: $3,976,000.
The estimated present value of Margaret’s DB pension: $350,000. That is what someone with no pension would have to save to generate the same income.
Monthly outlays (Margaret only): Mortgage $1,915; property tax $485; home insurance $185; electricity $120; heating $75; maintenance, garden $150; transportation $415; groceries $840; clothing $200; gifts, charity $275; vacation, travel $705; dining, drinks, entertainment $435; club membership $25; subscriptions $35; health care $35; life insurance $145; phones, TV, internet $245; RRSP $900. Total: $7,185. New surplus will go first to her RRSP.
Liabilities: Margaret’s mortgage $118,900 at 5.19 per cent; Jack’s mortgage $400,000 at 5.7 per cent. Total: $518,900.
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