Managing Proceeds From Rental Property Sale: A Boomer & Echo Financial Makeover
After the birth of their daughter, the Mitchell’s financial priorities have changed. How can this couple use the sale proceeds from their rental property to kick-start their new financial goals?
Family Profile
Frank and Tara Mitchell are enjoying a busy family life with 2 ½ year old Lucas and 7 month old baby Mia. Frank (35) works as a public servant earning $83,000 per year. Tara (33) is currently on maternity leave and will make $61,000 as a nurse when she goes back to work four days a week in June.
They are finding that they are in a position to take stock and review their financial priorities.
Residing just outside of Edmonton, the Mitchell’s own their home, worth $600,000. They pay $1,700 per month on their $254,000 mortgage, which comes up for renewal in March. They want to pay off their mortgage as quickly as possible.
Related: Mortgage free at 31: Worth the sacrifices
The Mitchell’s are risk averse when it comes to debt. They want to pay cash for their vacations, cars, and home renovations.
In December they sold a rental property for $260,000 that Frank bought five years ago for $140,000. They’ll net about $130,000 after fees, but before capital gains taxes. They are wondering what to do with the proceeds. Frank has no interest in becoming a landlord again.
They are socially conscious, and their $35,000 in RRSPs is invested in an “ethical” mutual fund that has returned an average of 8 percent a year over the last five years, but comes with a MER of 2.06%.
Frank’s RRSP deduction limit is $51,000 and Tara’s is $24,000.
Both Frank and Tara contribute to their employer’s defined benefit pension plan. Frank will have a full 35 years by the time he’d like to retire in 2036, while Tara will only have 22 years of service by that time and will have to take a reduced pension.
Frank has $10,000 in Canada Savings Bonds that he purchased through a payroll deduction program at work. The bonds have now matured and he’s open to trying a different investment.
Frank and Tara have private term life insurance plans through Manulife with $500,000 coverage each, plus 2 times salary group coverage through their employers.
They do not have wills.
Goals:
- Determine how best to use the proceeds from the sale of their rental property
- To be mortgage free in 10 years.
- Retire by 2036 with 70% of last working year’s salary.
- Max our RESPs for the kids.
- Buy a new vehicle in 2017 (est. $40,000).
- Annual vacations with kids.
The Mitchell’s wonder what steps they can take over the next 12 months to solidify their financial plan and put them on a path to financial freedom.
Financial Plan
By keeping their goals simple the couple can achieve a lot. The proceeds from the sale of their rental property provides a great opportunity to kick-start their finances. Once Tara goes back to work, after expenses, they will have a monthly surplus of $3,300. Here’s what they can do.
Rental property proceeds:
First they’ll need to calculate Frank’s tax liability on the approximately $60,000 capital gain. A rough estimate is $20,000.
They can make a prepayment on their mortgage of the allowable 20%, or $64,000, that their bank allows on the original balance of $320,000.
Related: Should you pay off your mortgage early or invest?
Frank should make a lump sum contribution to his RRSP to help offset the additional tax liability for 2014. A $30,000 contribution could reduce his taxes owing by approximately $11,000.
The Mitchell’s should take $7,000 from the proceeds and have some fun: Frank wants to buy a new bike for $4,000, and Tara wants to start an annual summer vacation tradition for the family.
The remaining $20,000 should be used to start funding their Tax Free Savings Accounts, which have been opened, but no contributions made as yet. For 2015 they’ll each have available contribution room of $36,500.
Mortgage:
After the prepayment their mortgage balance will have reduced nicely – down to $190,000. At renewal in March they should lock-in to these historically low five-year fixed rates (at less than 3 percent) and increase their monthly payment to $2,000 in order to pay off the mortgage even faster.
Related: How to negotiate your mortgage renewal like a pro
The prepayment, coupled with the extra monthly payments means the Mitchell’s will be mortgage-free in just seven years.
RESPs:
The Mitchell’s should continue maxing out their RESP contributions ($2,500 annually per child) in order to take advantage of the 20 percent government grant (CESG).
RRSPs:
Their RRSP is currently invested in the RBC Janzi mutual fund that advocates, “socially responsible investing.” However, the top ten holdings are very similar to the S&P/TSX Composite Index, which is the benchmark.
Compare its MER of 2.06% to the MER of the iShares S&P/TSX Composite Index at 0.05%. While returns are similar at 8% over 5 years, high fees can ultimately erode returns in the long run. The Mitchell’s should consider switching to the lower cost ETF.
TFSAs:
The Mitchell’s should focus on filling up their TFSAs as both a short-and-long term savings strategy. Starting in June, once Tara’s back to work part-time, they can afford to each contribute $1,500 per month to their TFSAs until they’ve exhausted the unused contribution room.
One TFSA should be invested in high interest savings, or other easily cashable products to pay for their annual vacations, new vehicle and future renovations. The other can be invested for the long term to provide additional income at retirement.
Canada Savings Bonds
The Canada Savings Bonds payroll savings program is an easy way to save, but with CSBs paying as little as 0.5 percent, they’re a poor investment even in this low rate environment.
Frank should cash out the $10,000 and place it in a high interest savings account. From there he can decide whether to use the funds to top up his RRSP, make a lump sum mortgage payment, or keep the cash on hand as an emergency fund.
Will and Power of Attorney
This was not one of the Mitchell’s concerns but they should have wills and powers of attorney drawn up. They need to assign a guardian for the children in case both of them die prematurely.
Final thoughts
While a lump sum RRSP contribution helps reduce their taxes owing in 2014, the Mitchell’s don’t need to emphasize their RRSPs for retirement savings going forward. That’s because, with two defined benefit pension plans and a paid-off home in seven years, this couple is well positioned to meet their retirement goals.
Would you like to be featured in the next Boomer & Echo financial makeover? Send us an email with your question or financial dilemma.
