Money Makeover: Beach bums

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DAVID LIPNOWSKI / WINNIPEG FREE PRESS (June 23, 2010) Money Makeover: whether its financially possible to have home in the tropics

Spending winters in a tropical paradise is an ideal retirement dream. For most people, the closest they'll come is an intense daydream while staring at a poster of a white beach and palm trees as they're getting their teeth cleaned at the dentist.

But Rick, 60, and Jane, 58, have every intention of making this vision of a post-work Eden come true when they retire.

Having recently married, both their second time around, they have pooled their assets to buy property in Mexico's Yucatan Peninsula. They own two homes in Winnipeg and plan to sell one in the next year.

The proceeds will be used to build their winter dwelling down south and pay off debts, including $11,000 on credit cards and another $78,000 on a line of credit.

Both have pension plans, which will pay them a combined, gross income of $4,300 every month.

They also have $140,000 in RRSPs, and they will receive severance packages and vacation pay totalling about $45,000 when they retire -- Rick from the provincial government and Jane from a non-profit organization.

Rick also has $128,000 in non-registered investments, but he borrowed $110,000 against his home to purchase the investments.

"I did that three years ago, just about at the peak," he says, adding he won't sell until its value increases more.

They plan to have their winter home ready when they retire in 2012. Eventually, they will sell their other home in Winnipeg and use the proceeds to pad their nest egg.

But they won't be spending the entire year in paradise. They know they have to come back to ensure they live here long enough to still qualify for government benefits.

Jane owns a lake cottage jointly with a sibling, so they'll spend the other half of the year lakeside instead of seaside.

"We know it's a good plan, but we don't know whether it's a doable plan," Rick says, adding they'd love an expert's opinion.

Retirement planning specialist Daryl Diamond says Rick and Jane need to carefully examine their income versus expenses in retirement.

"People usually tend to underestimate what they do spend or will spend on things," says the certified financial planner with Diamond Retirement Planning in Winnipeg. "So they should have a budget that reflects what in fact they are experiencing combined with consideration for things they don't necessarily spend money on now that they will in retirement, such as flights to and from (their winter home)."

They should also double-check their budget for another reason. Their current monthly net income is $6,600, but they estimate their current monthly expenses at $3,500.

"If they were able to live on this today, they should be saving about $3,000 a month that they did not need for expenditures," he says. "My feeling is that they may be a little 'light' on what they are planning on for discretionary spending at $500 per month."

Still, Diamond says their retirement income should be substantial when their pensions are combined with the Canada Pension Plan.

"Rick will be able to split up to 50 per cent of his formal pension income with Jane at the time they jointly file their taxes, and each of them will be entitled to the pension credit on this income," he says. "Using a basic tax calculation for Manitoba, this should result in an initial household, after tax, cash flow of approximately $4,775 per month, well above the $3,500 budget amount."

Of course, they can supplement shortfalls with RRSPs and once they reach age 65, Old Age Security will augment their income even more. Because they already would have significant income, they will be able to use their RRSP at their discretion until age 71. At that point, they have to convert those savings to a registered retirement investment fund (RRIF) or an annuity, declaring at least 7.38 per cent of capital annually as income. Diamond says they should consider drawing early from their RRSPs before they start receiving OAS to ensure they won't be hit with a larger tax burden after 65 when they have less flexibility.

"The addition of the OAS payment would have them at a level of taxable income that borders moving into the next bracket," he says. "Even if the RRSP income is not needed for regular cash flow, there may be merit in taking some income, paying the tax at a lower rate and moving the after-tax receipt into a tax-free savings account (TFSA)."

Besides evaluating their retirement cash flow, managing their real estate assets also requires careful consideration.

Diamond says the sale of their homes should gross $425,000 combined. Taking away real estate fees, commissions and debt repayment, they should have roughly $300,000 in after-tax proceeds. (It should be noted debt repayment does not include Rick's $110,000 investment loan. Because Rick said he only will sell the investments once they have increased in value, Diamond says that debt won't really have an impact on the sale of their homes.)

"Ideally, they can build their home (in the tropics) and have cash left over."

But they also have the CRA's principal residence exemption rule to consider. Normally, the capital gain on a principal residence is not subject to taxes. The fact they both owned homes before they got married complicates matters, but it does not eliminate the preferential tax treatment under the rule.

"Let's assume that we are referring to Jane's house since they are living at Rick's, so any growth since the date she no longer resided in it could be deemed a capital gain upon disposition and subject to taxation," he says, adding the taxable gain is only from the date she moved in with Rick to the time of sale. "It would be in their best interest to discuss this with an accountant."

Aside from that, Diamond says, there's one last area of concern for Rick and Jane -- and that's risk management. Through Rick's employment benefits program, he will have the opportunity to buy supplemental health and life insurance without taking a medical.

"But if it is his or Jane's intent to acquire life insurance coverage, they should first apply outside of work for individual coverage to see if, and on what basis, coverage would be granted," he says. "The non-medical conversion of your group life insurance is about the most expensive coverage you can buy, other than what you see advertised as 'guaranteed issue insurance' on TV."

Still, Diamond says all of these concerns can be addressed relatively quickly, and their plan is definitely viable.

"In a perfect setting, they would have their retirement property paid for, no debts of any kind and some surplus money invested in a non-registered account to use for larger expenses or to fund ongoing contributions to their TFSA accounts," he says. "Other than that, they are good to go and may just want to add a little extra to their budget for the cost of year-round sunscreen."

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Rick and Jane's finances

�ñº INCOME

Rick: net monthly: $2,800; annual gross: $54,000

Jane: net monthly: $3,800; annual gross: $75,000

Projected retirement monthly, gross pension incomes

Rick: $3,100

Jane: $1,300

EXPENSES

�ñº Monthly: $3,000 fixed; $500 discretionary

�ñº DEBTS

Rick

Line of credit 1: $110,000 (invested)

Line of credit 2: $20,000

Mortgage: $21,000

Credit card: $5,000

Jane

Line of Credit: $58,000

Credit card: $6,000

�ñº ASSETS

Rick

RRSP: $61,000 (mutual funds)

Non-registered: $128,000 (mutual funds)

Severance package: $25,000

Vacation pay upon retirement: $10,000

Home: assessed at $250,000

Other: 50 per cent share in Mexican property ($35,000)

Jane

RRSP: $79,000 (mutual funds)

TFSA: $10,000

Cash: $3,000 cash

Severance package upon retirement: $10,000

Home: assessed at $175,000

Other: 50 per cent share in property in Mexican property ($35,000); 50 per cent share in cottage assessed at $250,000.

Republished from the Winnipeg Free Press print edition June 26, 2010 B15