The majority of retirees want to remain in their homes and age in place as long as possible. Indeed, most of the financial plans for my retired clients project them to stay in their home, or a home of equivalent value, for their entire lives.
That makes perfect sense if you plan on leaving your paid-off home to your beneficiaries upon your death.
But, for many retirees, a fully paid-off home represents untapped equity that will lead to underspending throughout retirement, or at least a serious reduction in standard of living as they age.
The solution is to consider a home equity release strategy – a term I first heard last month when Dr. Preet Banerjee wrote about biases around house rich, cash poor homeowners.
Below are the seven different home equity release schemes that were listed:
- Reverse mortgages
- Home Equity Lines of Credit (HELOCs)
- Second mortgages
- Refinancing
- Selling to downsize into a smaller owned home
- Selling to move into a rental home
- Selling to lease-back the same home
Unlocking all or a portion of your home equity can significantly improve your retirement outcome, and yet many retirees are not even considering their own home equity release strategy as part of their retirement plan.
Below I’m going to share an example of a recent retired couple, Joe and Linda Davola, who live in Ontario and retired at the end of last year at ages 63 and 60, respectively.
They have combined assets of $1.4M saved across their RRSPs, TFSAs, non-registered savings, and Joe’s LIRA. They also have a paid-off home worth $1.1M for a total net worth of $2.5M.
Joe and Linda would like to spend $100,000 per year after-taxes throughout retirement. They work with an advice-only financial planner to see what’s possible.
The planner runs a projection that shows after-tax spending of $100,000 per year, rising with inflation at 2.1% annually until Joe’s age 75 year, and then increasing by just 1.1% annually until Joe’s age 95 year.
In this scenario, Joe and Linda remain in their paid-off home and don’t touch the equity. Unfortunately, they run out of money in Joe’s age 91 year.
In addition to this less than ideal outcome, the planner also points out that life doesn’t always move in a straight line. In fact, they will most certainly incur one-time costs such as home renovations, vehicle replacement, bucket list travel, or financial gifts to their children or grandchildren throughout retirement.
The planner meets with Joe and Linda and together they come up with a list of these one-time expenses that will or may occur over the next 5-10 years.
- Bucket list trip to New Zealand in 2025 – $20,000
- Kitchen renovation in 2026 – $40,000
- Finance a new vehicle from 2027 to 2030 – $12,000 per year
- Upgrade HVAC in 2031 and 2032 – $7,500 per year
When we add the one-time expenses into the plan, and keep spending constant at $100,000 per year, the outcome gets significantly worse. Now the Davolas run out of money at ages 83 and 80, respectively. That’s eight years earlier than expected.
At this point it becomes crystal clear that in order to maintain their desired standard of living the Davolas will need a home equity release strategy.
They debate selling the house and renting, but Linda likes the peace of mind that comes with home ownership and worries about rising rental costs and the threat of having to move again.
Home Equity Release Strategy
The Davolas decide the best course of action would be to downsize to a condo in 12 years (Joe’s age 75 year). They’d sell their home for $1.4M and buy a condo for $900,000* – unlocking half a million dollars in home equity that can be used to maintain their standard of living.
*That $900,000 condo purchased in 12 years is the equivalent of purchasing a $700,000 condo today.
Their planner runs the numbers and suggests that not only can they continue spending $100,000 until age 95, but they can also give an early inheritance of $50,000 each to their two children from the proceeds of their house sale.
Here’s what it looks like:
By “releasing” $500,000 of untapped home equity, the Davolas can fill up their TFSAs and give an early inheritance gift to their children.
They can maintain their desired lifestyle until age 95, and still leave an estate to their two children worth $1.73M. That’s in future dollars, mind you, so it would be like leaving an estate worth $835,000 today – or the condo plus $135,000 in savings.
Final thoughts
The desire to remain in your home as long as humanly possible and avoid long-term care makes perfect sense. But life doesn’t always turn out as planned, and it’s wise to avoid making decisions when our options and mental capacity may be limited.
That’s why it’s smart to consider your home equity release strategy upfront at the beginning of retirement.
Can you honestly see yourself remaining in your family home into your 80s and 90s?
We also tend to drastically overestimate our ability to endure significant spending cuts. I hear all the time from retirees who think they’ll just cut $20,000 per year or more from their spending at 75 or 80.
In reality, the decline in spending from the “go-go” years to “slow-go” years to “no-go” years is much more subtle. Like, instead of spending continuing to rise with inflation it rises by inflation minus 1% in your slow-go years, and then simply remains flat in your no-go years.
So, instead of relying on a drastic reduction in lifestyle spending (poor future you!), consider how using all or a portion of your home equity can fit into your retirement plan and allow you to maintain the standard of living that you’d like to enjoy.
And, for my lifelong renters, it’s true that you won’t have the margin of safety and options that home owners have in retirement, but I’d also argue that if you’ve prudently saved and invested the (often significant) difference between renting and home ownership, you’re already on track to maximize your spending throughout retirement without leaving any untapped home equity on the table.
You might not have a hot clue how much you plan to spend in retirement, especially if those days are still a decade or further away. Even those nearing retirement may not have a good sense of their desired retirement spending amount.
A good rule of thumb is that you’ll likely want to enjoy the same standard of living you enjoyed in your final working years, if not enhance it with extra money for travel, hobbies, helping your kids, and spoiling your grandkids (if possible).
When preparing retirement plans for clients I’ll look closely at their current spending, and then stress-test the heck out of their plan to determine their maximum annual spending (the most they can sustainably spend without running out of money by age 95).
This offers clients a spending range between a comfortable floor (what they’re spending today), and a safe ceiling (their maximum sustainable spending limit). For example, let’s assume you spend $84,000 after-taxes in your final working years. A thorough stress-test of your plan suggests you can spend up to $96,000 per year without running out of money by age 95.
Knowing this, clients have the option to dial up spending in good times or to dial it back in bad times. Reality probably means settling into the sweet spot of spending $90,000 per year.
Retirement spending of $84,000 likely gives you the ability to continue making TFSA contributions into retirement – socking away money for large known one-time expenses, unplanned future spending shocks, or to build up tax free savings for your estate. The trade-off is sacrificing some standard of living and not spending up to capacity.
Spending up to the $96,000 ceiling offers the ability to maximize life enjoyment, particularly in the “go-go” years of early retirement. The trade-off is no room for extra savings contributions to the TFSA for a rainy day, and potentially less margin of safety for unplanned spending, poor market returns, or longer than normal life expectancy.
One area of spending not talked about enough is your one-time cost categories like buying new vehicles, renovating or repairing your home, gifting money to your children, or taking a bucket list trip. These expenses are often large, are not factored into your annual spending needs, and tend to occur in the early years of retirement, squarely in what I call the retirement risk zone (the period of time between retirement and when pensions and government benefits kick-in).
Throw a bad stock market outcome into the mix, and this could be a recipe for disaster if not planned for appropriately.
All the more reason why retirement planning should be done 5-10 years before your retirement date. This gives you a chance to understand your retirement spending needs, list and prioritize your one-time expense categories, and hopefully knock some of those items off while you’re still working and earning income.
This also gives you a chance to consider working part-time as a way to combat the retirement risk zone and ease yourself into full-stop retirement living.
This Week’s Recap:
No posts from me in a while as much of our free time has been sucked up by kids’ activities (dance season) and birthdays.
From the archives: Forget about asset location – why you should hold the same asset mix across all accounts
One final note on our mortgage renewal with Pine Mortgage. Everything is in place now and we’ve received the $3,000 cash back promotion along with a reimbursement for the home appraisal that they ordered. The dashboard is nice and user friendly, and they allow payments from our regular TD chequing account.
Speaking of TD, they reimbursed us for the mortgage payment that automatically came out of our chequing account on May 1st.
Finally, it looks like Pine Mortgage will get more attention now that they’re been chosen as Wealthsimple’s mortgage partner. That’s right, Wealthsimple is now offering mortgages (through Pine) and has some great deals for Wealthsimple customers (existing and new).
Promo of the Week:
Want to earn some serious credit card rewards? Start with the Amex Cobalt card – the best card for everyday spending in Canada with 5x points for food & drink. Sign up and spend $750 per month on this card to get an extra 15,000 Membership Rewards points (plus the 45,000 points you’d earn if you spend $750 per month on a 5x spending category).
Then use your own referral link to refer your spouse or partner (called: activating Player 2), and have them do the same thing. This could be worth a total of 120,000 Membership Rewards points in a year, plus another 10,000 for the referral bonus.
Next, use this link to sign up for your own American Express Business Gold card and earn 75,000 Membership rewards points when you spend $5,000 within three months. Then activate your player two for a chance to earn another 90,000 points (15k referral plus 75k welcome bonus).
If you’re looking for hotel rewards, this one is an absolute no-brainer card to have in your wallet. The Marriott Bonvoy Card gives you 55,000 bonus (Bonvoy) points when you spend $3,000 within the first three months. Not only that, you get an annual free night certificate to stay at a Marriott hotel (easily worth $300+), making this a card a keeper from year-to-year. The annual fee is just $120.
Weekend Reading:
A question I’m hearing more and more from clients and readers alike: Is it wise to begin investing when stocks are at an all-time high?
A Wealth of Common Sense blogger Ben Carlson on the gambler’s fallacy in the stock market.
David Aston explains why, when it comes to Canadian government pensions (CPP and OAS), timing is everything.
Jason Heath shares why your retirement may be different than you expected:
“Retirement math, whether based on rules of thumb or professional planning, can overlook some of the real-life implications of being a retiree. Running out of money is a risk, but so is running out of time.”
You want to retire early. Should you start your RRIF withdrawals sooner or later?
Trading meme stocks is gambling, not investing. But, have you ever gambled with meme stocks? Preet Banerjee walks us through the latest drama with GameStop stock:
Work can maintain engagement, keep us all sharp, as well as continue social connections and even a sense of purpose. Here’s why we should douse the FIRE movement and adopt CHILL instead.
A good piece by Dana Ferris on how to determine the appropriate retirement date. I recently wrote something similar about the best time of year to retire.
Long-time renter and blogger at Of Dollars and Data Nick Maggiulli writes about the rise of the forever renter class:
“This is where many in the unwilling Forever Renter class find themselves. They have good jobs. They make good money. But interest rates are also the highest they have been in two decades. As a result, if they want to borrow money to buy a house, they will pay for it dearly.”
PWL Capital’s Ben Felix explains why there’s room for good financial planning – and for error – before the June 25 capital-gains tax change (G&M subscribers).
Ben and his Money Scope podcast co-host Mark Soth teamed up to explain what the proposed capital gains changes mean for business owners.
Jamie Golombek says be careful moving your TFSA — or the CRA might come knocking. That’s because you need to let the financial institutions handle the transfer rather than withdrawing money from one TFSA and depositing it into another.
A really important article by Anita Bruinsma on what kind of money messages you’re sending your kids.
Used cars versus new cars: which market is offering better deals, and how has the landscape changed after the pandemic-era disruptions to supply?
Travel and credit card expert Barry Choi says there’s a loyalty arms race on, but not being loyal might be a consumer’s best move.
Finally, speaking of credit cards and loyalty programs, here’s a deep dive into the anatomy of a credit card rewards program. Interesting stuff!
Have a great weekend, everyone!
Some readers were appalled to learn that my wife and I completely drained our TFSAs in 2022 to fund a larger down payment on our new house. Okay, maybe not appalled – but it did raise a few eyebrows.
Remember, inflation was running hot and interest rates started to rise in March of that year. While we didn’t know the extent of the eventual rate hikes, it was clear that our new mortgage interest rate would be substantially higher than our existing one.
Besides that, we didn’t want to sell our existing house until we took possession of our new home. That meant taking on new debt from both a home equity line of credit and a builder mortgage (used to fund the new house construction at specific stages of completion). Both of these loans were floating at Prime rate – which eventually ended up at 7.2%.
Not relishing the prospect of carrying a larger mortgage balance at an ever increasing interest rate, we made the decision to tap into our TFSAs to the tune of about $175,000. That helped fund the first two construction draws before we had to turn to our lines of credit.
We moved into the house in April 2023, sold our previous house in May, and held back about $50,000 from the sale to pay for landscaping, window coverings, and some furniture.
Fast forward to 2024 and my wife and I are still sitting here with empty TFSAs. Well, until now.
On Friday we each made a $9,000 contribution to our TFSAs, with a goal of each contributing a total of $28,000 in 2024.
Here’s my TFSA catch-up plan:
- 2024 – $28,000
- 2025 – $28,000
- 2026 – $28,000
- 2027 – $40,000
- 2028 – $35,000
That will get me fully caught up on unused room, plus the new annual room accrued each of those years. From 2029 onward I’ll only need to make the annual maximum contribution to my TFSA.
My wife has less overall contribution room, so she’ll need to contribute $28,000 per year from 2024 to 2027, and then contribute $13,000 in 2028 to fully catch up on her TFSA contribution limit.
How are we contributing at such a high rate for the next five years? Part of it comes from one-time expenses we incurred in 2022 and 2023 that can now be redirected towards savings.
But we also made a conscious decision to pay ourselves more from our business so we can fund the extra TFSA contributions. The trade-off is that we’re investing fewer dollars inside the corporation.
It’s a delicate balance to pay yourself enough to fund your personal spending and savings goals, while retaining earnings inside the corporation to invest and grow at a lower tax rate (hopefully to fund future consumption).
The upcoming changes to the capital gains inclusion rate inside of corporations was also a key consideration.
We’ve already triggered a capital gain inside of our corporate investing account of about $70,000, which, after some nifty accounting, we’ll be able to withdraw $35,000 tax-free as a capital dividend.
Finally, it just made good sense to pay a bit more tax upfront over the next five years to fill up our TFSAs quickly and get those funds invested and growing tax-free for the long haul.
So, fear not, dear readers. Our TFSAs will be maxed out again soon. Hopefully we can stay away from any new show homes for while and they’ll stay that way 🙂
This Week’s Recap:
In last week’s edition I celebrated our investments surpassing the $1M mark for the first time. I’m really excited to add our TFSAs back to the mix of accounts and really give us a diversified set of options to draw from in retirement.
From the archives: A look at closet indexing – the dirty little secret of the mutual fund industry.
A final update on our mortgage switch from TD to Pine Mortgage. Pine came through and got the mortgage switched before the end of the month, and I can’t say enough good things about working with them so far. Your mileage may vary, of course, but they got the job done.
TD, on the other hand, discharged the mortgage on April 30th and then still took our monthly payment out on May 1st. Not cool!
Promo of the Week:
Want to earn some serious credit card rewards? Start with the Amex Cobalt card – the best card for everyday spending in Canada with 5x points for food & drink. Sign up and spend $750 per month on this card to get an extra 15,000 Membership Rewards points (plus the 45,000 points you’d earn if you spend $750 per month on a 5x spending category).
Then use your own referral link to refer your spouse or partner (called: activating Player 2), and have them do the same thing. This could be worth a total of 120,000 Membership Rewards points in a year, plus another 10,000 for the referral bonus.
Next, use this link to sign up for your own American Express Business Gold card and earn 75,000 Membership rewards points when you spend $5,000 within three months. Then activate your player two for a chance to earn another 90,000 points (15k referral plus 75k welcome bonus).
If you’re looking for hotel rewards, this one is an absolute no-brainer card to have in your wallet. The Marriott Bonvoy Card gives you 55,000 bonus (Bonvoy) points when you spend $3,000 within the first three months. Not only that, you get an annual free night certificate to stay at a category five hotel (easily worth $300+), making this a card a keeper from year-to-year. The annual fee is just $120.
Weekend Reading:
Of Dollars and Data blogger Nick Maggiulli explores why people make “bad” financial decisions.
A nice piece on the rise of zero-based budgeting, a system in which you assign a job to every dollar of gross income.
Author Morgan Housel smartly explains how to think about debt:
“Once you view debt as narrowing what you can endure in a volatile world, you start to see it as a constraint on the asset that matters most: having options and flexibility.”
Should you max out your RRSP before converting it to a RRIF? Jason Heath explains what to consider before making this pivotal conversion.
Mark Walhout highlights the risks of adding your children to your accounts:
On a similar note, estate & trust professional Debbie Stanley answers an often asked question – can transferring ownership of a house help avoid probate tax?
Rounding out the estate planning trifecta, here’s Aaron Hector on whether you are tax planning for you, or your estate:
“In a nutshell, every dollar of income that you accelerate is a dollar of income that you don’t have to report in the future, and you get to choose what tax rates get applied to that dollar; the current marginal rate, or the future marginal rate (which could be higher). It’s easy to see how this process can result in your paying a lower average lifetime tax rate.”
Ontario’s Sunshine List discloses the salaries of government employees making more than $100,000, but hasn’t been adjusted for inflation since debuting in 1996. Preet Banerjee says the directory, which now has more than 300,000 names on it, is mostly a list of people who can’t afford to buy a home in Ontario.
Finally, Jason Heath answers the following question – Do all the advice articles about waiting to take CPP at age 70 take into account the calculation of your eligible amount if you stop working and contributing at, say 60 years old, and therefore have 10 years of no contributions?
Enjoy the rest of your weekend, everyone!