Can Clement and Uma, both in their mid-40s, afford to buy a $2-million cottage?

Clement and Uma are in their mid-40s with two young children, good paying jobs and a house with a mortgage in Southern Ontario.

He earns $185,000 plus a variable bonus in financial services, while she makes $118,000 working for the provincial government. Clement is moving into a new position soon that will pay more.

With their careers in an upswing, they are thinking of renovating their house and maybe buying a cottage. But they aren’t sure they will have enough to retire on, Clement writes in an e-mail.

Both now have defined benefit (DB) pension plans although Clement’s will change to a defined contribution plan in his new job. Clement’s existing pension will pay $32,250 a year at age 62. Uma has a defined benefit pension that will pay $67,100 a year at age 57, falling to $52,600 at age 65 when the bridge benefit ends.

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If their pensions, RRSPs and government benefits are enough, “can we use our other savings to fund the purchase of a vacation place and home renovation?” Clement asks.

They would use their tax-free savings accounts and unregistered investments for a down payment on an expensive cottage.

Their other goals include funding their children’s higher education and leaving the house and cottage to their children.

Their retirement spending goal is $120,000 a year after tax.

We asked Guillaume Dumais, a certified financial planner with Objective Financial Partners Inc., to look at Clement and Uma’s situation.

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What the expert says

Clement and Uma ask whether drawing on their TFSAs and non-registered accounts to buy a $2-million cottage will jeopardize their long-term financial security, Mr. Dumais says.

In preparing his forecast, he assumes the couple’s TFSAs and non-registered accounts will be liquidated for the cottage purchase and that their RRSPs, work pensions and Canada Pension Plan benefits will be the primary sources of retirement income.

He assumes an inflation rate of 2.5 per cent a year, real estate appreciation of 4 per cent and an average annual rate of return of 5 per cent.

Clement and Uma’s decision to buy a $2-million cottage using their TFSAs and non-registered accounts will deplete these accounts, but is strategically planned to not impact their retirement security, Mr. Dumais says. The following is an analysis of three alternative retirement strategies.

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First, the final tax minimizer strategy. This approach focuses on minimizing taxes at the end of life by prioritizing RRSP withdrawals. It results in a total income tax of $3,113,054 with no final taxes due, and the funds last for 47 years. “This strategy ensures that their retirement funds are used efficiently, maximizing the after-tax estate,” the planner says.

Second, the retirement cash flow maximizer strategy. It aims to maximize early cash flow by drawing from non-registered accounts first, then RRSPs. It results in a total income tax of $3,274,194, with final taxes of $608,085, and the funds also last for 47 years. “This approach provides flexibility in the early years of retirement, allowing for potential lifestyle enhancements or unexpected expenses,” Mr. Dumais says.

Third and last, the balanced drawdown strategy. This approach balances withdrawals across all accounts, providing a steady income stream throughout retirement. It results in a total income tax of $3,039,859, final taxes of $485,173, and funds lasting 47 years. “It offers a middle-ground solution, balancing tax efficiency with income stability.”

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“Each strategy confirms the sustainability of their retirement plan, ensuring that Clement and Uma can maintain their lifestyle without compromising their financial security.”

The stress-testing helps support their ability to buy the cottage and fund their spending well into their 90s based on their current trajectory. “The scenarios are good for context but their cash flow planning and tax strategy will need revisiting and could evolve over time.”

Next, Mr. Dumais looked at the financial impact of the cottage purchase.

“The decision to use TFSAs and non-registered accounts for the cottage purchase is significant, as it reallocates a large portion of their liquid assets,” he says. “However, this strategy is underpinned by a robust retirement plan focusing on RRSPs, pensions and CPP.” The impact of this decision includes:

• Liquidity considerations: The depletion of TFSAs and non-registered accounts reduces short-term liquidity, but the structured withdrawal from RRSPs and pensions ensures continuing cash flow.
• Retirement security: The reliance on indexed pensions and secure CPP benefits provides a stable income base, reducing the risk associated with market fluctuations in retirement savings.
• Tax implications: Utilizing non-taxable and taxable accounts for the purchase allows for strategic management, preserving growth within RRSPs.

“This approach ensures that while a significant asset purchase is made, the overall retirement security remains intact.”

Transitioning to a retirement plan that relies heavily on RRSPs, pensions and CPP requires careful planning, Mr. Dumais says. With no RRSP contribution room left for Clement and $50,000 available for Uma, strategic contributions and withdrawals are essential to maximize tax efficiency and income stability, the planner says.

The DB pension plans for both Clement and Uma, with indexed adjustments, provide a reliable income stream. “Managing the bridge benefit and understanding the impact on long-term income is crucial.”

Delaying CPP benefits can enhance payouts, providing additional income security. The timing of these benefits should be aligned with other income sources to optimize cash flow and tax impact, he notes.

As for investment strategy, the RRSPs should be managed with a focus on preserving capital while ensuring growth, Mr. Dumais says. “A diversified portfolio aligned with their risk tolerance and retirement timeline will help mitigate market risks.”

To maximize the after-tax estate for heirs, they should consider direct beneficiary designations on registered accounts to bypass probate and potentially reduce estate taxes, he says.

Because health care needs may increase with age, planning for potential costs is essential, Mr. Dumais notes. This includes considering long-term care insurance or setting aside funds for medical expenses.

In the short run, the risk of using a large portion of their investments to do a renovation and buy a cottage emphasizes the importance of insurance. Good disability coverage for both of them maintains cash flow if one of them becomes disabled. Life insurance provides a payout if one of them dies. Uma’s job security is strong, while Clement’s is riskier. So that would be one reason to stagger the reno and the cottage purchase to minimize uncertainty.

Continuing financial reviews will ensure the couple’s plan remains aligned with changing circumstances, allowing for adjustments in strategy to meet evolving needs and goals.

“Clement and Uma are well prepared to meet their retirement objectives, leveraging their structured approach to asset management and income planning,” Mr. Dumais says. “Regular assessments and strategic adjustments will support their long-term financial stability and lifestyle aspirations.”

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Client situation

(Income, expenses, assets and liabilities provided by the applicants.)

The people: Clement, 45, Uma, 46, and their two children, 5 and 10.

The problem: Can they buy an expensive cottage without jeopardizing their long-term financial goals?

The plan: Regardless of which drawdown strategy they choose, they have enough to buy the cottage and still meet their retirement spending goals.

The payoff: The freedom to buy a cottage that the whole family can enjoy while they are still young.

Monthly after-tax income (current): $17,785.

Assets: Bank accounts $105,000; his non-registered stock portfolio $386,000; her non-registered portfolio $480,000; his TFSA $320,000; her TFSA $143,000; his RRSP $520,000; her RRSP $22,550; registered education savings plan $83,000; residence $1,400,000. Total: $3.5-million.

Estimated present value of their DB pensions: $781,250 for his; and $1,387,500 for hers. This is what someone with no pension would have to save to generate the same retirement income.

Monthly outlays: Mortgage $2,745; property tax $965; water, sewer, garbage $250; home insurance $170; heating $250; maintenance $350; garden $50; transportation, parking, transit $920; groceries $850; child care $600; clothing $400; gifts, charity $100; vacation, travel $1,000; dining, drinks, entertainment $550; personal care $100; club memberships $100; golf $50; sports, hobbies $200; subscriptions $50; health, dental insurance $50; life insurance $80; communications $295; RRSPs $855; registered education savings plan $415; TFSAs $1,000. Total: $12,395.

Liabilities: Mortgage $450,000 at 3.7 per cent.

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Some details may be changed to protect the privacy of the people profiled.