Melissa and Gary thought buying a rental property would help enhance their retirement picture.
Instead, they've had nothing but headaches.
Retired for three years, the couple in their 50s owns two condos.
"One will be an income property in a few years, but the other we thought would appreciate more, and it hasn't," says Melissa, who earns a pension of $61,000 a year. "Our problem with that one is we paid for it on a line of credit, and we're not earning enough to pay anything against the principal, and when we have associated costs -- like repairs -- it comes out of our pockets."
The condo they hope will be an income property soon has an $18,000 mortgage and is worth $90,000. On the other, worth about $135,000, they owe $118,000 on a line of credit. They also have a mortgage of about $75,000 on their home valued at about $280,000.
Yet even though the condo they paid for with the line of credit is costing them money, they are hesitant to sell it, she says.
"We're waiting because we think it should appreciate a lot more than it has."
But the more they think about their retirement future, the more they wonder if owning both rental properties is actually hurting their bottom line instead of enhancing it. They would like to travel more than they have, but they're afraid they might spend too much -- already a bit of a problem.
"I realize that we're already probably spending every cent we earn on frivolous things," says Melissa, adding they spend about $1,200 a month on groceries and as much as $2,500 on dining out and entertainment.
So far, they haven't had to use their RRSPs, about $127,000, but even figuring out how to use that source of savings presents a planning dilemma.
"We don't know what to do, but we're concerned we should start melting them down gradually to save on taxes," she says, adding excess withdrawals from their RRSP would be reinvested in their TFSAs.
Then there's CPP to consider.
"I'm wondering whether I should draw CPP early," she says. "All my friends are going: 'Take it! Take it!' "
With so much to consider, Melissa says she and her husband often feel paralyzed about how to proceed.
"We do not have a clue as to how to set our priorities."
Financial planner and money manager Doug Nelson says the best way for Melissa and Gary to address their problems is to start with a simple question: Are they earning enough to meet their needs?
Here's how the numbers pan out.
On work pensions alone, they're receiving about $90,000 a year -- income that can be divided equally under pension-splitting legislation that will lower their tax burden.
"By doing so, they end up with $45,500 in taxable income each, with tax payable of approximately $9,000 each resulting in a combined monthly after-tax income of $6,000 per month," says the author of Master Your Retirement and partner at Nelson Financial Consultants in Winnipeg.
Next up are their needs -- the expenses. Excluding the mortgage and line-of-credit payments, they spend about $4,450 a month, based on their estimates, leaving them with $1,550 a month in excess cash flow.
Nelson says he deliberately left out the debt payments associated with their real estate -- even the mortgage on their home -- because if they were to objectively look at their overall situation, they'd likely come to the following conclusion:
Sell the income properties.
"By selling assets and paying down the debt, Melissa and Gary eliminate approximately $10,000 in loan payments per year," he says. "When you consider that they don't need (rental) income to live and they aren't making much income anyway or capital growth from these properties, then why are they complicating their life by owning these properties?"
So in Nelson's expert opinion, the rental properties are indeed a hindrance to their retirement well-being.
Once sold, Melissa and Gary could use the proceeds to pay off the mortgage on their home, and any remaining cash could be invested in their TFSAs.
What they should not do, however, is start 'melting down' their RRSPs and investing withdrawals they don't need in their TFSAs.
"If they did, Melissa and Gary would pay close to $3,000 in taxes for no good reason."
Instead, they should only draw on their RRSPs when they need money.
While they're concerned about paying OAS clawbacks and paying higher taxes later if they leave their RRSPs largely intact, Nelson says this likely isn't a concern for them given the size of their RRSP portfolio.
By the time they are eligible to receive OAS, for instance, the clawback threshold should be about $75,000 net annual income or more per retiree.
Even with additional taxable income from their registered accounts (RRSP/RRIFs), their individual, annual net incomes would likely not exceed this threshold, so they have no good reason to tactically withdraw from their RRSPs early just to avoid taxation problems such as the clawback.
Of course, if they do need additional income prior to age 65, they should draw on their RRSPs instead of receiving CPP early.
"Always draw income from the lowest-earning source first," Nelson says.
Given their savings are all invested in GICs, it's unlikely they could earn seven per cent a year, which is the amount their CPP income would be reduced for each year they start receiving the pension before age 65.
"This is actually very different than the advice we would have provided 10 years ago," he says.
The reason being, the discount rate applied for taking CPP early has increased by 20 per cent while returns on conservative investments on GICs have cratered.
Until they have to make mandatory annual withdrawals when their RRSPs are converted to RRIFs at age 71, ideally they should only withdraw from their RRSPs in the event of an emergency.
Nelson says it's likely Melissa and Gary shouldn't otherwise have need for additional cash flow from their registered accounts because, with the properties gone and their home paid for, they will have about $18,000 more a year to spend on vacations and other goals.
And if they find they need additional cash, they can first try to find it by cutting their food and entertainment spending. Reducing these expenses by a third would probably increase their free cash flow by as much as $1,200 a month.
In fact, Nelson suggests they start budgeting, whether they need to save money or not, because this exercise will help them figure out exactly how much money they need to live on month-to-month and, correspondingly, how much income they require.
But based on the estimates they have provided, Nelson says they're in great shape, and they have no reason to hold onto real estate investments that are causing them stress and costing money.
"Melissa and Gary are in a good position, but it appears prudent to simplify and refocus on those things that are most important to them today and in the years to come."