Q: My wife (58) and I (57) are house rich, cash poor and just got approved for a line of credit for $600,000. We’re planning to retire at 65. We have no savings, no RRSPs and no TFSAs. When I reach retirement, I would like to get about $20,000 per year to spend on top of CPP and OAS. That’s the reason why I applied for the line of credit. Right now I’m still working and my annual income is about $70,000. If I borrow to invest, I could claim the interest on my tax return. Is it the right move or is there a better way to prepare for retirement?—T.
A: In an ideal world, we all go into retirement with a pension, investments and a paid-off house. In the real world, that doesn’t always happen. All you can do is try to plan the best course of action.
First off, the maximum CPP at age 65 is currently $12,460 and OAS is $6,765. Entitlement to CPP is based on years of contributions, while OAS is based on years of residency in Canada. These pensions are indexed to inflation. OAS is clawed back if your income exceeds $71,592 by 15 cents on the dollar.
In planning your retirement, I think you need to be careful about doing “quick math.” You may need another $20,000 right now, but in 20 years, $20,000 today is more like $29,719 assuming 2% annual inflation.
But if we just consider your situation very broadly, T., I’d say you have four options:
1) Borrow against your home equity to fund expenses in retirement
2) Borrow against your home equity to invest now
3) Downsize your house
4) Sell your house and rent
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If you borrow in retirement to fund your expenses, you can use your line of credit. You borrow money, you pay interest and you likely use the line of credit, in part, to make your interest payments. Those already in retirement who can’t qualify for a line of credit may need to consider a reverse mortgage, which is another way to tap your home equity, albeit likely at a higher interest rate and with less flexibility.
I often hear people warning seniors that borrowing against your home equity reduces the estate left to your kids. That’s true. But so does drawing down on your investments. With all due respect to your kids, funding your retirement is more important than leaving them an inheritance.
If you borrow now to invest, the key becomes earning a higher rate of return on your investments than the interest rate you’re paying on the line of credit. In theory, stocks should generate a return well in excess of the prime borrowing rate, but in practice, there are no guarantees. Borrowing to invest is always risky business, but it is an option. In this case, you’d probably be best to consider whether to fund RRSPs, TFSAs or non-registered investments. Only interest on funds invested in a taxable non-registered account is tax-deductible.
Downsizing your house, whether now or in retirement, is another option worth considering. It will provide you with money to invest without having to borrow to do it. It may also bring down your living costs now and in the future.
Selling your house and renting also provides money to invest—lots of it. So that solves a short-run problem. But in the long run, it may or may not be the best choice. It all boils down to how much your rent may cost relative to the value of your current home and your assumption about investment returns. Depending on the rental rates and home values in a given neighbourhood, renting may not be a terrible idea if rents are low enough. But renting has its own drawbacks such as bad landlords, less control over your home environment and not participating in real estate price increases.
One big risk that exists for all of these scenarios is a real estate downturn, but that’s a topic for another column.
Suffice to say, T., you have options. I’m biased in this assertion, but I think a bit of number crunching could provide you with perspective. A conservative and thorough retirement plan could project potential outcomes under the various scenarios. That might provide some perspective for making your decision.
Beyond that, all I can say is that chances are no matter which course of action you take, things won’t turn out exactly as you expect. But you have to make your choices today based on reasonable expectations of the future. And no matter which scenario is likely to give you the best financial outcome, you need to balance your decision with the level of comfort that comes with making that choice.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products.