Real estate figures largely in Juanita and Jose's retirement plans.
The middle-aged couple with no children own three properties. Yet lately, one of their two income properties has been a source of stress, and they're considering selling it and buying another that may come with fewer headaches.
"Another home may not cash flow as much on paper from rent, but my expenses will be less by significant amounts for the year," says Jose, a teacher in his early 40s.
"I purchased it (the troublesome property) for $119,000 and I'd be hoping to sell it for around $130,000."
Jose says they figure it's best to buy another property and port the mortgage rather than selling the home and investing the profits in something else because he would have to pay a penalty for breaking the mortgage -- and there would be taxes and fees too.
Yet the couple still wonders whether they have a little too much exposure to real estate.
While they have about $275,000 in equity in their three properties, including their principal residence, they only have about $60,000 in RRSPs, TFSAs and other savings.
Their current retirement plan will rely heavily on their defined-benefit pensions, but they also hope their rental properties will provide them with additional retirement income.
For that reason, they are leaning toward a strategy of paying down the mortgages as quickly as possible.
The problem is they haven't been able to do that lately because the one property is eating up free cash flow. In fact, they've been running deficits recently, incurring about more than $6,000 in credit card and line of credit debt.
Moving forward, Jose says they should be on better ground -- particularly if he can sell the troubled rental property and buy a better one. Still, after months of costly repair bills, they're having second thoughts.
"What is the best line of attack?" asks Jose, who has a disability and qualifies for a Registered Disability Savings Plan. "Should we focus on savings or should I be using that to eliminate my mortgage earlier?"
Wealth manager and financial planner Doug Nelson with Nelson Financial Consultants in Winnipeg says Jose and Juanita have a lot of moving parts to their plan -- maybe too many -- so they should focus on simplifying their finances.
He suggests a few steps to accomplish this.
One is eliminating their credit card debt.
"What money should they use to pay off this debt? Money that is also highly taxed and provides a low return," he says. "Specifically, they should use cash in the Canada Savings Bonds (about $2,500), as they are likely generating a very low rate of return."
As opposed to earning about two per cent or less on their money, they could quickly eliminate their credit card debt, which has a 20 per cent interest rate.
The next step is maximizing pre-tax investments -- yes, a savings strategy for their RRSPs.
When considering how much to invest into the RRSP, they need to pay attention to the tax brackets, Nelson said.
"You would always maximize the contribution room of the higher-income earner," he says.
Jose earns $71,900 with a marginal tax rate of 39.4 per cent while Juanita earns $49,500 taxed with a marginal rate of 34.75 per cent.
So, Nelson suggests they focus on contributing about $4,900 a year to Jose's RRSP.
"Once that is added to Jose's RRSP, then the marginal tax rate will be the same for both Jose and Juanita."
But Jose also can contribute to an RDSP, and it is worth considering because, based on their incomes, each dollar contributed to this plan will attract $1 in government grants up to $1,000 annually.
The contributions, however, are made with after-tax money so if they only have so much money to contribute toward savings, they need to weigh the benefits of an RDSP versus an RRSP.
With an RRSP contribution of $4,900 annually to Jose's account, they receive a refund of $1,900.
With an RDSP contribution of $1,000 a year, they receive $1,000 in additional grant money, but any contributions above that amount annually will provide no tax savings. If they can manage contributing to both accounts, that's great. If they have to choose one or the other, the RRSP strategy is likely better.
With regard to deleveraging -- debt reduction -- their focus should be paying down non-deductible debt once the credit card is paid. This means paying off the mortgage on their principal residence as soon as possible. Otherwise, based on its current 24-year amortization, a lot of their money will be going toward interest costs.
"Based on the current mortgage interest rate, deposits will total another $389,000 with interest costs of $114,000."
And the longer they carry the mortgage -- their largest source of debt -- the more exposed they are to the risk of rising interest rates.
"If interest rates rise to five or six per cent, their mortgage costs will increase significantly," he says.
"It is really important to get this mortgage down to an amortization of 10 years or less as quickly as possible."
Another important step in streamlining their finances is a balanced budget. The biggest obstacle here is the property generating more bills than income. If they can't get that straightened out, or can't sell and find another income property within their budget, they need to consider selling.
Any profit, after fees, penalties and taxes can be used to pay down the mortgage on their principal residence. If they reach their annual payment maximum for their mortgage, any remaining cash should be invested for the long-term -- ideally in dividend producing stocks or funds -- in their TFSAs.
"The TFSA is far, far more effective than a non-registered investment account or a rental property."
Simply put, any long-term returns in the TFSA will be tax-free whereas income and capital gains from real estate are taxable.
Having said all this, however, Nelson says they should give selling both rental properties serious thought.
"The best financial approach may be to sell both and use the proceeds to achieve more tax-efficient outcomes."
They could pay down the mortgage on their principal residence, and once that's paid in full, they could then focus on maximizing their TFSAs for retirement.
Given Jose and Juanita should have pretty comfortable retirement incomes based on their work pensions, OAS and CPP -- all fully taxable income -- they need a strategy for saving and debt repayment that will enhance tax efficiency going forward, Nelson says.
But not only that, it will probably make life a lot simpler.
"Complicating their life today with additional rental properties, which are less tax efficient, is likely not going to help them achieve their retirement goals as quickly or efficiently," he says.
"My estimate is that they will find that they likely will have more income at retirement without rental income from properties than they realize."