COUPLE NEEDS TO PUT EXTRA CASH TO WORK

ANDREW ALLENTUCK

Two men in B.C. we’ll call Ralph and Eddy have made their home together for many years. Each is 65. They worry they may not have enough money to maintain their modest way of life with a few vacations each year.

“How do we make our savings work harder without taking on more risk?” they ask. “It’s too late in life to lose a lot of money.”

Family Finance asked feebased financial planner Guil Perreault, head of Guil Perreault Financial Inc. in Winnipeg, to work with the men. His answer is simple: “Yes, they have enough savings to maintain their lifestyle and have their modest trips each year. But they can do much better with their capital.”

To maintain spending of $2,198 a month, the men can count on two Old Age Security pensions of $579 a month each and Canada Pension Plan payments with a combined value of $856 a month. Eddy also has a modest defined benefit pension of $300 a month. The total, $2,314 before tax, is subject to only nominal income tax because, with eligible pension income split, their effective tax rate is about five per cent. Their simple way of life is adequately financed, though they would like to spend as much as $10,000 a year on travel, more than four times their present budget.

BRING ASSETS TO CANADA

The men can have much more income if they put their approximately $500,000 of financial assets to work. Almost all of that is being left idle in cash and retirement accounts, earning next to nothing. Part of that hoard is Eddy’s US$225,000 balance in an Individual Retirement Account held with a U.S. investment bank. He could transfer it to Canada within rules provided by the Income Tax Act. Eddy can do the switch without any penalty, Perreault says, but there would be a cost in headaches and, perhaps, recoverable tax.

The U.S. plan provider will withhold 15 per cent of the sum transferred, but that charge will be claimable on their Canadian tax returns. The amount will be reduced by Canadian foreign tax credits provided they have enough income tax payable in Canada to absorb those credits. Eddy needs to check his RRSP space to handle the transfer and the potential transfer should be reviewed by a tax professional, Perreault advises.

RAISING INVESTMENT RETURNS

Leaving $500,000 in cash earning at most one per cent in savings/chequing accounts is a gift to the bank. Yet taking on a lot of capital risk at this stage in the men’s lives would be precarious and wrong, Perreault says. Cash feels secure to the men and is in the short run, but is self-defeating in the long run. Inflation is running at a few per cent a year. Even doling the money out now as a form of tax averaging from their $512,500 of cash in RRSPs and the U.S. accounts would be sensible provided they spend it or get a better return.

Ralph and Eddy have weighed investing in a rental property against investing in financial assets. They can do some of each, of course.

A rental investment in a small condo might cost them $170,000 with a potential rental income of $1,200 a month, Perreault suggests. With a 20 per cent down payment, the business would have upfront, one-time costs totalling $40,000 made up of $34,000 for a down payment, $1,700 for land transfer tax and $4,300 for legal fees.

They could anticipate gross annual rental income of $14,400 less property tax of $1,750, insurance and maintenance costs of $1,250, and mortgage interest of $6,488 on a 30-year, 2.5-per-cent loan for net pre-tax revenue of $4,912 per year. Take off $750 for income tax and they would have an after-tax return of $4,162, an 11 per cent return on their equity in this example.

That’s a hefty return, yet the assumption that they could get a property for $170,000 and have worry-free income is not guaranteed. Vacancy risk, tenant damage, rising interest rates, rising property and income tax rates and other risks make the projected return subject to change.

The men could also buy shares in a dividend-focused exchangetraded fund or put together a portfolio of a few bank and public utility shares and have a four per cent dividend stream and some change or price appreciation of perhaps three per cent a year. That would be a seven per cent total return for their RRSPs and cash with low income tax based on the dividend tax credit and only 50 per cent of capital gains subject to taxation. It could supplement income when one partner dies. The survivor would have lost at least one Old Age Security benefit and a Canada Pension Plan payment.

Either solution — the real estate investment or purchase of financial assets — would be better than letting cash sit at one to two per cent in a chequing account or a short-term guaranteed investment certificate. If the men can get a blended return of seven per cent before three per cent estimated inflation, their $512,500 cash would add four per cent or $20,500 a year to their pre-tax income. That money could be used to replace or upgrade their aging cars and could go a long way toward fulfilling their goal of a $10,000-a-year travel budget.

That additional money could also be used for long-term care, Perreault notes.

“If we add the lost returns on $500,000 at four per cent for 10 years, that’s $200,000 with no compounding. I would suggest that they get a feel for stocks or real estate rental. They can live well if they make a commitment to some equity investment or slowly starve with a pile of cash earning approximately nothing.”