FP Answers: Can I retire at age 43 on $48,000 annually?

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This will be tight, but you can do it, experts say

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By Julie Cazzin, with Allan Norman

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Q: I am 43 years old and want to retire now on $48,000 net annually. I’ve worked 19 years and earn $95,000 a year. My investments include three rental properties worth $1.4 million with net income totaling $38,000 annually. I have a $700,000 principal residence, a registered retirement savings plan (RRSP) worth $90,000, a defined-contribution (DC) pension worth $60,000 and $20,000 in savings. All the properties have mortgages. Would I have to sell any properties to reach my goal? And should I pay off some mortgage debt before retiring? — Achille

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FP Answers: Achille, this will be tight, but you can do it.

Let’s look at: RRSP withdrawals, claiming the Capital Cost Allowance (CCA), the cash dam strategy and a combination of the first three, as well as switching your mortgage to a line of credit (LOC), selling your home and renting an apartment.

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Modelling your desired scenario gives you an income shortage of $25,000 per year until age 64, assuming you want an annual income of $48,000 after tax and mortgage payments, indexed at two per cent.

After age 65 and then at age 73, you have an income surplus of $15,000 and $23,000, respectively. That’s because you start receiving your reduced Canada Pension Plan and then because your mortgages are paid off.

You also risk dying with too much money, so we should bring some of that future income into today so you can enjoy a comfortable lifestyle.

First, let’s try withdrawing from your RRSP to fill the income gap. Your DC pension is locked in until age 55 (Ontario). After that, you can move 50 per cent of the total value to your RRSP. Drawing on your RRSPs gets you to age 46, so RRSPs alone won’t do it.

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What if you claim the CCA on your rental properties?

You can deduct a portion of the building (not the land) on rental properties from your income each year, up to four per cent of the original cost minus the amount already claimed. The exception is in the first year year the property is purchased, when you can claim up to four per cent on only 50 per cent of the property cost (not the full 100 per cent).

I estimate you can claim a CCA of $26,000 in 2022. That’s the amount you can deduct from your income, saving you $6,000 in tax. Or, put another way, that’s $6,000 less you have to come up with to get to $48,000 after tax.

You need to understand the CCA “recapture” rules. If the building hasn’t depreciated in value by the time it’s sold, you have to add back the amount of CCA claimed. If you claimed CCA in 2022 and then sold the building in 2023, you’d have to add the $26,000 CCA claim to your income. If you’re still in the same tax bracket, you’d pay an extra $6,000 in tax.

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Claiming the CCA can be beneficial when you’re in a high tax bracket. Most people would invest the $6,000 tax refund so the $6,000 investment will grow enough to offset the recapture by the time you sell the rental property.

In your case, Achille, if you plan to hold onto your rental properties, you may prefer to use the tax advantage to support your lifestyle today and not be as concerned about future tax.

Still, claiming the CCA alone won’t get you to $48,000.

What about trying the cash dam strategy? Again, this works better if you had a higher taxable income.

The cash dam can be used by owners of businesses that are not incorporated as well as by rental properties.

The goal is to convert your home mortgage into a tax-deductible line of credit (LOC). You do this by using your rental income to pay down your home mortgage and using a LOC to pay rental expenses. The interest on the LOC will likely be tax deductible.

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The tax savings on the cash dam strategy still aren’t enough to get you to $48,000. But this strategy shows that if your mortgage is converted to an interest-only LOC, and you don’t pay down your mortgage, you come much closer to your income goal.

Will it matter if your mortgage is no longer being paid off? Should you draw money from your RRSP, pay tax and then pay down your mortgage? This is a way to bring some future home equity back to today.

OK, but even combining all three strategies won’t get you to $48,000.

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Converting your mortgage to a LOC helps, so what would happen if you sold your home and rented for $20,000 per year, and used the invested proceeds, at five per cent, to fund your lifestyle?

That works. It is almost perfect in that you have $48,000 per year indexed at two per cent, after tax and mortgage payments, and your final estate value will be about $6.5 million in actual dollars — or $2.5 million in today’s dollars. You can watch this video for more details.

Don’t like the idea of selling your home? You can simply work a few more years.

Allan Norman, M.Sc., CFP, CIM, RWM, is both a fee-only certified financial planner with Atlantis Financial Inc. and a fully licensed investment advisor with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca. This commentary is provided as a general source of information and is intended for Canadian residents only.

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