Q: I recently inherited some farm land and it is worth $200,000. I have a relatively large mortgage of $205,000 and credit card debt of $40,000 along with a truck payment of $500 per month. My initial thought is to pay off my truck and credit card debt and whatever I have left I will pay down my mortgage. I hope to retire in about 10 years, so my hope is I can pay the rest of what remains on the mortgage over that period.
Is this a good plan or would you advise otherwise? I really don’t have much fluidity in terms of cash flow at present and therefore I’d like to pay off the debt I have as much as I can. My income is $90,000 with two dependents, 17 and 14 years of age. The home I live in is valued at approximately $300,000. —Rich
A: First off, Rich, I like to make sure people understand the tax implications from inheriting. The inheritance itself is not specifically taxable to you, but if the farmland rises in value from what it was worth when the person who willed it to you died and when you sell it, you may have a capital gain, 50% of which is taxable on your tax return. Selling costs like real estate commissions and legal fees would be deductible. So it’s unlikely that you will have a tax bill to pay if the sale value is comparable to the inheritance value.
Is the farmland currently farmed or is it arable? I’d consider whether the better investment is to have it farmed or to sell it and a realtor who has experience with farm properties would be a good starting point. I’ll assume it’s reasonably liquid and better to sell for the purposes of my answer, in particular given your debt and cash flow worries.
I think I’d definitely pay off the credit card debt as a starting point, Rich. Unless it’s a short-term introductory rate, credit cards typically carry a double digit interest rate.
On the truck payment, I’d say it depends on the interest or finance rate. Is it a lease that has a low or zero interest rate? If so, I’d consider keeping it in place. If it’s a higher rate loan from the bank, I’d pay it off.
That still leaves you with well over $100,000, Rich, which could put a big dent in your mortgage. But before you pay it down, I’d consider some of the alternatives.
You have teenage children. Are they likely to go to college or university? Are you likely to provide financial support for their education? You might want to consider topping up their RESPs if they’re not yet maxed out. You can contribute up to $5,000 per year per child and get a 20% Canada Education Savings Grant from the government. This $5,000 is the $2,500 maximum annual contribution eligible for the CESG plus one carry forward year. If your 17-year old turned 17 last year (2014), then you missed your last chance to contribute to an RESP for that child. If they’re 17 this year, you may not be eligible for government grants unless you have contributed at least $2,000 previously or at least $100 in any four years up to and including the year they turned 15.
Do you have unused RRSP room, Rich? Depending on your province of residence, the size of an RRSP contribution and your other tax deductions, you may be able to get a tax refund of between 36% and 46%. Given the low interest rate environment and that your mortgage should be gone in under 10 years, I’d say there’s a compelling reason to consider an RRSP contribution and using the resulting tax refund to pay down your mortgage as well.
As a final consideration, you might contribute to a TFSA. TFSAs of course have no tax refunds or government grants, but at least your money grows tax-free. That said, I’m lukewarm on TFSA contributions when someone has debt because I find most Canadians end up with cash and GICs in their TFSA earning 2% and are worse off versus paying down debt at higher rates.
Even a balanced mutual fund might not be worth it in a TFSA, because half your balanced mutual fund investment is likely earning 2.5% on bonds and that return is disappearing to the 2.5% MER fees your mutual fund is incurring. In other words, half your balanced mutual fund may be generating a nil net return. So without a more aggressive asset allocation, a low-cost investment vehicle or ideally, a combination, many Canadian’s TFSAs end up as duds compared to the guaranteed return of debt repayment.
Especially given your adversity to debt and your cash flow concerns, I’d be on the fence between TFSA contributions and debt repayment and likely opt for paying down your mortgage instead. That is, after paying off your credit card, possibly paying off your car debt and considering RESP and RRSP contributions first.
Your mortgage might have restrictions on how much of the principle you can pay down each year without penalty, Rich, so consider paying down some of your mortgage principle now and some more after your next anniversary date.
Presumably your cash flow will improve by just getting rid of the credit card debt and potentially the car payment. If you pay down some of your mortgage principle as well, consider changing your amortization to bring your payments down and free up your cash flow even more for things like RRSP and RESP contributions. Hopefully you can still have a 10-year amortization to line up with your retirement target and also have lower monthly payments.
One of the key recommendations I make to people who come into sudden money, like your, Rich—whether a gift, business sale, severance or inheritance—is to resist the compulsion to immediately make all the right choices. Don’t do anything but leave it in cash at first. Slowly contemplate your options and take action on purpose rather than under pressure and haphazardly.
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 whatsoever.