At age 55, Sarah is wondering when she can afford to retire from her $89,000-a-year media job, spend time travelling and “never have to worry about money.”Alia Youssef/The Globe and Mail
Like most people, Sarah has had some hits and misses over the years when it comes to investments. Now, at age 55, she is wondering when she can afford to retire from her $89,000-a-year media job, spend time travelling and “never have to worry about money.”
Years ago, Sarah inherited about $100,000. She bought a house jointly with other family members in Vancouver, which they eventually sold for a tidy profit. Her mistake was that she didn’t buy back into the Vancouver real estate market, Sarah writes in an e-mail. “Eventually, I decided to go ahead and buy in Victoria instead.” She rents the house out at a profit. In time, Sarah borrowed against the equity in her Victoria property to buy a co-op apartment in Vancouver, where she lives now.
Sarah has a defined-benefit pension plan at work that will pay her about $1,550 a month at age 60 and $2,375 at age 65. She has substantial registered savings and a fair amount of debt as well.
If she retires as early as age 61, Sarah asks, how much can she spend? She’s concerned about having to pay capital gains tax if she sells her rental property. “Should I go and live in the rental property for a year and make that my principal residence before I sell?”
We asked Janine Guenther, president of Dixon Mitchell Investment Counsel of Vancouver, to look at Sarah’s situation. Ms. Guenther holds the chartered financial analyst (CFA) designation.
What the expert says
“As a single person, Sarah lives well within her means on her current salary and has the extra monthly income after expenses from her revenue property in Victoria,” Ms. Guenther says.
Sarah contributes regularly to her RRSP in addition to the company pension plan. Any surplus cash flow should be going to fund her tax-free savings account. Sarah has about $58,600 in her TFSA, short of the maximum contribution to date of $81,500.
If Sarah retires at age 61, she could take both her work pension and Canada Pension Plan early, the analyst says.
In the years from age 61 to 80, Sarah’s active retirement, the forecast assumes Sarah has $84,000 a year in after-tax income to spend and $60,000 a year from age 81 to 95, adjusted for inflation. Ms. Guenther assumes that Sarah will live to age 95 and earn an average annual rate of return on her investments of 6 per cent. By the time Sarah retires, the inflation rate is assumed to have stabilized at 2 per cent a year.
First off, Sarah has to decide where she would like to live. “Considerations such as proximity to services, one-level living, and a supportive community are extremely important,” the analyst says. “As we age, we are slow to adapt to changes so it makes sense to do some upfront work now to think about whether she wants her current residence or the Victoria property as her principal residence.”
Ms. Guenther has prepared two scenarios, each offering different opportunities and tax consequences.
In Scenario 1, Sarah sells her rental house in Victoria when she retires and pays off the loans against it. There would be an estimated capital gain of $470,000, half of which would be taxable. Any costs associated with capital improvements would reduce the overall gain on the sale. After capital gains taxes are paid and the debt against the rental property extinguished, Sarah would have about $340,000 left to invest. She should use this money to top up her TFSA and create a portfolio of dividend-paying stocks, the analyst says.
“Under this scenario, she could start collecting the company pension and CPP at age 62, using a monthly draw from the non-registered savings – mainly the property sale proceeds – to achieve her annual spending requirements,” Ms. Guenther says. At age 65, Sarah would begin collecting Old Age Security benefits, reducing the amount she would have to draw from her non-registered savings. Once the non-registered savings are depleted, she could begin drawing from her RRSP and TFSA.
Sarah would continue to pay off her mortgage on the co-op under this scenario because her forecast portfolio returns of 6 per cent are higher than the current interest rate on her residence mortgage of 2.39 per cent, the analyst says.
Fast forward to Sarah’s age 90, at which time the forecast assumes Sarah sells her co-op apartment, giving her another influx of cash to help cover the cost of health care in her old age.
In Scenario 2, Sarah sells her Vancouver co-op when she retires and moves to her rental property in Victoria. “Selling the co-op will not have any tax implications because it is her principal residence,” Ms. Guenther says. “She would invest the $315,000 proceeds in her non-registered investment portfolio of dividend-producing stocks. Dividends are taxed more favourably than interest income.”
Sarah has asked about ways to minimize the capital gains tax on her Victoria house. Simply put, she will owe capital gains tax on the property for the years it was rented out. When she moves in, there will be a deemed sale of the property for tax purposes, but the capital gains tax payable can be deferred until the house is sold, Ms. Guenther says.
As well, Sarah might be able to rent out the house for up to four more years without having to pay capital gains tax for those years. She has said she wants to travel when she retires.
Sarah could make a principal residence election, leave the country for a couple of years and rent out the property while she travels without losing the principal residence exemption, Ms. Guenther says. “This is a bit more complicated but might make sense in the lifestyle equation if it includes travelling for an extended period and going back to retire in Victoria,” she says.
“Sometimes, travelling is more fun if you go somewhere and live there for a while. With this principal residence election, it is possible to do this. It is meant to give people more options.” It is important that Sarah consult a tax expert when selling real estate in her personal name because the Canada Revenue Agency reporting rules have changed in the past few years.
In this second scenario, Sarah could think about selling the Victoria house down the road, especially if the property layout does not suit her long-term living requirements, Ms. Guenther says. Her calculations assume Sarah sells the second property at age 75.
With either property sale, Sarah will need to do some tax-smart planning around her portfolio construction, the analyst says. “Specifically, eligible dividends in Canada are tax-advantaged over interest income. This is particularly important when it comes to income after the age of 65, when there is the potential for an Old Age Security clawback.” In 2022, OAS begins to be clawed back after $79,845 a year of income and is fully clawed back when income exceeds $129,757.
Client situation
The person: Sarah, 55
The problem: Can she retire early and be confident that she won’t run out of money? Is there a way to sell the rental property and minimize capital gains tax?
The plan: If she wants to retire early, Sarah will have to sell one or the other of her properties. She should weigh the alternatives carefully because each has different advantages and disadvantages.
The payoff: A comfortable retirement with the assurance she will not run out of money
Monthly net income: $5,590
Assets: Co-op $530,000; revenue property $1.3-million; RRSPs $517,000; TFSA $58,700; non-registered $10,000; estim. present value of her DB pension $395,000. Total: $2.8-million
Monthly distributions: Mortgage $975; co-op fee, heat, cable $400; property taxes $155; property insurance $45; hydro $35; maintenance $200; transportation, gas, car insurance, maintenance, parking $420; groceries $550; clothing, dry cleaning $280; gifts $70; communications $70; vacation $150; entertainment, drinks, dining out $230; personal care $150; club membership $25; health care expenses $280; RRSP, TFSA $730; pension plan contributions $185. Total $4,950
Liabilities: Mortgage, principal residence: $215,000; mortgage, rental property: $523,400. Total: $738,400
Editor’s note: In a previous version of this article, Sarah’s estimate of her future Canada Pension Plan benefits of about $1,440 a month was incorrect. In fact, the planner estimated Sarah will collect a reduced CPP starting at age 62 of $606 a month. The error does not affect the planner’s forecast.
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Some details may be changed to protect the privacy of the persons profiled.
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