Q: My husband and I are teachers and we will be retired and collecting pensions in approximately 8 – 10 years. We have been mortgage-free since 2008, have RSPs, some TFSAs and we are approaching maximum contributions allowed in our children’s RESPs.
In 2015, we purchased an investment property. I’m wondering whether it would be wise to cash in our RSPs and use the after-tax amounts to pay down the mortgage on our investment property, which is substantial right now (and I’m concerned about interest rates going up).
I’m also starting to wonder whether we’ll be making too much money in our retirement and therefore will likely be paying a lot in tax for our RSP withdrawals. I stopped contributing years ago for this reason (my husband still does). We could use that RSP money right now, not in the future. We’ll also be inheriting two other properties from my parents in the coming years so we’ll also have those two rentals bringing in income for us as well. Any suggestions on what we could do?
A: Before you consider shifting assets to pay down your current mortgage do some analysis on your current investment property. Make sure it is a sound investment before you do anything. Treat it like a business. Determine if, in fact, it is a viable investment today and also into the future. Consider these questions regarding your current property and the two other properties to be inherited.
Do these properties have positive or negative cash flow currently? What is their net annual rate of return—considering capital appreciation and cash flow? Are they profitable? Are they simple & painless to manage? How much personal time and energy is involved? Never get attached emotionally to any investment. If you determine these properties to be sound then consider pay-down scenarios.
The interest on the mortgage for your current investment property is tax deductible which will decrease your personal taxes (assuming this is owned personally and not in a corporation). If you’re worried about interest rates increasing consider locking into a longer-term fixed rate mortgage. Use a mortgage broker to shop around and find the lowest long-term fixed rate but also consider the contractual pay down privileges. Get a projection illustrating how this fixed rate impacts your current mortgage payment and the impact on the cash flow of the property.
What is the rate of return on your RSPs and TFSA? How liquid are these investments? Will there be any penalties for cashing them out? I am not sure what your current incomes and marginal tax brackets are today. It would be helpful to know this and also what your sources of income will be including future pension income to get a better picture of your tax rates.
Any RSP withdrawals will be fully taxable based on your marginal tax rates at the time of withdrawal. Meaning if you are in a 40% marginal tax rate today, then 40% will have to be paid back in the year of redemption (for every dollar you withdraw you will net 60 cents). I do not see withdrawing your RSP as a viable solution. Instead, consider withdrawing money from your TFSA’s as this will not trigger any tax. Once you have maximized your RESP contributions consider shifting those funds to decrease your mortgage.
The only way to know if you will be making too much money in your retirement and therefore paying considerable tax on your RSP withdrawals is to have a financial plan created to eliminate the guesswork. A personal income and expense sheet should be completed to determine your current and future income and expenses. Additionally, a tax projection is required to determine your current and future cash flow from all sources with the corresponding tax rates.
This requires you to be proactive today with your financial planning. What is your future income goal? What is the amount of net income per month you desire? When do you desire to have this income and for how long? Can this be achieved with your pensions and rental income in combination? Are you on track or off track?
You require an independent professional advisor to create an integrated aligned financial strategy considering your values, all your goals (both financial and non-financial) and all your financial affairs.
Dean Kendall is a Chartered Financial Consultant with Ideal Life Experience Ltd. in Calgary
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