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Cabin fever

Couple's lakeside retreat key part of retirement finances

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Sherman and Holly have a scheme to keep their exposure to the winter cold to a minimum in retirement.

"Our dream has been to retire in the spring of 2015, sell the house and live at our cottage for the summers and in Victoria in the winters, with hopefully a month or two down south somewhere," says Holly, 60, who is semi-retired.

Sherman's and Holly's finances

INCOME:

Sherman: $165,000 ($7,743/month net)

Holly: $28,228 ($1,972/month net)

Monthly expenses: $6,387

DEBT:

Mortgage: $136,306 at 3.5 per cent

Car loan 1: $16,449 at zero interest

Car loan 2: $19,279 at zero interest

 

ASSETS:

Home: $400,000

Cottage: $500,000

Sherman RRSP: $104,900

Holly RRSP: $37,000

Holly TFSA: $3,900

NET WORTH: $873,766

But the couple isn't entirely certain their plan will work.

While Holly earns a work pension worth $1,150 a month, Sherman, 64, is self-employed and only has $104,000 in an RRSP.

Aside from the $40,000 Holly has in her RRSP and a TFSA, most of the couple's wealth is tied up in their home and cottage.

They owe about $140,000 on the mortgage on their home worth $400,000, but they own their cabin, worth $500,000, outright.

The couple would like to hold onto the cabin because their children have mentioned an interest in taking over ownership one day -- not to mention Sherman and Holly would rather spend summers at the lake than in the city.

For the rest of the year, they estimate they will spend about $1,000 a month on rent to live on the coast and down south.

"I think our plan is doable because we're looking after selling our house somewhere in the area of $400,000 when combined with our current savings," Sherman says. "The problem is I'm not sure what can we invest in."

They have been considering investing substantially in an exempt- market real-estate deal that promises a 10 per cent annual return.

"I know some people who are doing it and they're saying it's unbelievable," he says.

Even with double-digit annual investment returns, Sherman still isn't sure he can even afford to retire.

"He says we're on the 'Freedom 85' plan," Holly says. "It's a big decision."

Certified financial planner Jan Fraser says Sherman and Holly's plan is workable, but it involves some risks and possibly an appetite for taking on debt later in life.

"If they want to make the cottage their permanent residence, realistically, they will need to be prepared to take some loans against it later in life," says the adviser with Winnipeg-based Fraser and Partners.

The couple could likely afford a lifestyle where they winter in warmer climes paying probably $2,000 a month rent -- more realistic than their estimate of $1,000 -- until Sherman reaches age 75.

At that point, travel insurance will likely be too costly.

Even if they could get travel insurance after Sherman turns 75, vacationing for months at a time would only put increased pressure on their finances, forcing them to borrow even more against the cottage.

Stopping travel once Sherman turns 75, Fraser estimates they will have to start borrowing against the cabin substantially by the time Sherman reaches his mid-80s, and they could incur more than $500,000 in debt if they live into their 90s while living at the cottage.

This certainly presents a problem if their children would like to keep the cabin, because there will not only be a tax bill to the estate, there will also be a large mortgage on it.

"If the kids actually want the cottage, Sherman and Holly need to have that discussion with them now."

One option is their children could buy the cabin from them so Sherman and Holly have money to maintain their lifestyle later into retirement without incurring debt against the cottage.

Alternately, their children could purchase whole life insurance for their parents that would pay a benefit to the estate to cover taxes and debt.

Fraser says both choices come with high price tags and may prove too expensive for their children.

Yet the equity in their cabin won't be enough on its own to fund Sherman and Holly's dream. Once they invest the proceeds from its sale, they will need their investment portfolio to generate an average annual return of 6.5 per cent to ensure they don't burn through the equity in their cabin too early, putting them at risk of having to sell it.

One strategy they should consider implementing straight away is borrowing against their home to contribute to Sherman's RRSP for 2013 and 2014 to generate a substantial tax refund while he is still earning about $165,000 a year.

Of course, they don't have much time left to make this decision, considering the deadline for 2013 is March 3, but they don't have to decide how to invest the money just yet. They simply need to contribute the cash to Sherman's RRSP.

Fraser says they should meet with their adviser or accountant to figure out just how much to contribute to get the biggest impact -- an analysis that may also include a decision on whether to declare their home or their cabin the principal residence.

While the cabin may have a greater gain in value, resulting in a higher tax bill when they eventually sell it, Fraser says their home should likely remain designated as their principal residence until it's sold so they can maximize the tax-free proceeds from the sale to fund retirement.

Simply put, they need as much cash as possible now to invest for the future. Furthermore, if they did deem their cabin as the principal residence, they would probably end up borrowing against it sooner, further increasing the debt and interest payments, likely creating an even bigger bill for their estate.

As for how to invest, Fraser says Sherman and Holly should think twice before making a significant investment in an exempt market real estate deal.

Private-equity deals offer high returns for a reason -- they're high risk.

"I just don't see them as safe enough to deliver what they promise, because the minute inflation boosts up, so do their borrowing costs, and where does that money come from?" Fraser says. "It comes from the money they're committed to paying out to investors."

A more prudent real-estate investment for them would be a REIT (real estate investment trust). This would involve less risk and it is liquid, meaning it can be sold quickly, whereas exempt market securities are very difficult to sell, especially when they don't turn out to be profitable.

Good REITs have long-term returns of about 6.5 per cent a year, Fraser says, but the couple will need more than real estate investments to build a portfolio to last them well into retirement.

She says they should approach managing their investments "like a pension plan," aiming to build a diversified portfolio with global reach that can provide steady returns, liquidity and long-term growth.

And they do require long-term growth because their plan, while workable, has little wiggle room for major costs, such as repairs on the cottage and health crises.

But Fraser says perhaps the best way for them to ease the cash crunch is to scale back their costs -- travelling less -- and increasing their income by working part-time longer.

Even then, they will still likely have to grow accustomed to being indebted later in retirement or consider the possibility of eventually selling the cabin and using the remaining proceeds to downsize.

"Carrying debt can be very stressful and it diminishes the freedom they envision," Fraser says. "It's a tough call to be consciously giving up your job, knowing you will likely have to go into debt down the road."

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition February 22, 2014 B11

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