Should we start investing, or stay focused on building our real estate portfolio? This is the question British Columbia-based Jennifer and Roland are trying to answer.
A blended family with four children from 18 to 22, Jennifer, 40, and Roland, 49, have purchased a primary residence, which is also a working farm, and three
.
They are at least 10 years away from
but are wondering if now is the time to start investing in equity markets to help fund their retirement or if they should purchase a fourth rental property.
They have $180,000 in a savings account. Jennifer earns about $30,000 a year after tax and Roland earns about $122,000 a year after tax. Roland has an employer pension plan that will pay about $32,000 a year before tax if he retires at 65. Jennifer is waiting to be approved for her employer pension at her new job. Their rental properties and farm bring in about $4,000 a year after expenses.
Jennifer and Roland’s primary residence is valued at about $600,000. They have a
at 3.9 per cent that costs them $2,300 a month, accounting for just about half of their total monthly expenses of $4,800. Their first rental property is valued at $405,000 and has a $150,000 mortgage at 1.9 per cent that is due in September; their second rental property is valued at $300,000 and has a $200,000 mortgage at 2.8 per cent that is up for renewal in two years; and their third rental property is valued at $280,000 and has a mortgage of about $285,000 at 6.29 per cent that is up for renewal in three years.
Ideally, Jennifer would like to retire with Roland in 10 years when she is 50 and he is 60. Is this possible?
What the expert says
With a total annual income of $216,000 before tax and monthly expenses of $4,800, or $57,600 a year, Jennfier and Roland should have more than $8,000 a month that can be directed toward savings, said Ed Rempel, a fee-for-service financial planner, tax accountant and blogger.
To maintain a retirement income of $4,800 a month after tax in retirement, they need before-tax income of $66,000 a year. Or, they need $510,000 of balanced investments earning an average of five per cent a year or $460,000 of equity investments earning an average of eight per cent a year in addition to their pensions, he said.
However, he is concerned the couple may have underestimated expenses, and not taken into account lifestyle costs such as travel, renovations and car purchases, which could bump up annual expenses by about $15,000 or $1,250 a month. This could increase their required retirement income to $85,000 a year before tax. Or, they would need $1,260,000 of balanced investments earning an average of five per cent per year or $950,000 of equity investments earning an average of eight per cent per year in addition to their pensions.
“If they can actually save and invest $8,000 a month, retiring when Roland is 60 and Jennifer is 50 is easily possible. If they invest their $180,000 in registered retirement savings plans (RRSPs) or tax-free savings accounts (TFSAs) and earn a modest five per cent a year, they would only need to invest $3,200 a month. This would also allow them $10,000 a year for vacations and $50,000 every 10 years for cars.
“Investing their savings plus $8,000 a month in balanced moderate risk investments could allow them to retire as soon as ages 57 and 47. Directing this money to equity investments could allow them to retire at 54 and 44.”
As for Jennifer and Roland’s overarching question – should they invest in the markets or continue to build their real estate portfolio? – Rempel said he sees it in terms of four issues:
- Which investment is expected to have the highest net return over time?
- Which investment has more tax advantages?
- Which of their three rental properties should they keep and which should they sell?
- How do they create their retirement cash flow?
“In general, equity markets have had far higher growth than real estate. For example, in the past 50 years, Toronto real estate has averaged growth of six per cent a year, but the Toronto stock market has had seven times higher growth, the global stock market 13 times higher, and the U.S. stock market 17 times higher.
“Jennifer and Roland’s rental properties have a total value of $985,000, but they only have $350,000 equity in the properties, so the real estate value is 2.8 times the amount they have invested in the three properties. Even if their properties grow at 2.8 times the normal real estate growth because of the leverage of using the bank’s money, that is still significantly less than the stock market has grown.”
Rempel also said the properties only produce about $4,000 a year in cash flow. “I have a general rule of thumb that when the mortgage on a rental property is down to half the value of the property, it is usually best to sell it to invest in equities for a higher return, less tax, and no work. With this rule of thumb, they may be best off selling their first rental property now and their second one in a few years, but they could hold on to their third rental property for quite a while.”
Starting to invest now can easily allow them to retire with their desired lifestyle, he said. He recommended they maximize Roland’s RRSP contribution room with a spousal RRSP for Jennifer. This will allow them to save tax (Roland is in a 44 per cent marginal tax bracket so he would get a refund of 44 per cent of any contributions) and split income in retirement. After maximizing the spousal RRSP, he suggested they maximize their TFSAs.
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