Once reduced to net disposable income (after taxes and social security contributions), Marthe* and Noël*’s family budget leaves them with little capacity for long-term investment savings for retirement.
The situation
Spouses Marthe, 43, and Noël, 45, are parents of three children aged 11, 12 and 16.
Their family lifestyle, active but on a reasonable budget, is relatively well supported by a gross family income of around $135,000 per year.
This family income is mainly composed of income from employment as self-employed workers, up to $115,000 per year, as well as $20,000 in net income from a four-unit building.
As for the family financial balance sheet, it already appears to be well endowed with assets, totaling some $1.6 million in total value, and nearly $1 million in net asset value after subtracting liabilities of $610,000 in mortgage loans on the family home and apartment building.
The catch, however, is that most of this asset value is concentrated in two residential properties: the family home valued at $600,000 (minus $160,000 in mortgage balance) and the four-unit apartment building valued at at $860,000 (less $450,000 mortgage balance).
In comparison, the financial assets of Marthe and Noël in registered savings accounts such as registered retirement savings plan (RRSP) or tax-free savings account (TFSA) remain very thin.
While they have no pension plan as self-employed, their RRSP assets total only $59,000, but with available contribution amounts totaling $107,000.
As for their TFSA accounts, they are still at zero with available contribution amounts of up to $88,000 for each of the two spouses.
In return, the Registered Education Savings Plans (RESP) of each of the three children are well stocked. They total some $70,000 in assets thanks to the annual generosity of their grandparents.
Numbers
Martha, 43 years old
Revenue : $120,000
- self-employment in health: $110,000
- net income from rental property: $10,000
Financial assets :
- in a registered retirement savings plan (RRSP): $45,000
- in a tax-free savings account (TFSA): $0
- in current savings account: $10,000
Christmas, 45 years old
Revenue : $15,000
- seasonal employment: $5,000
- net income from rental property: $10,000
Financial assets :
- in a registered retirement savings plan (RRSP): $14,000
- in a tax-free savings account (TFSA): $0
Family financial assets:
- in Registered Education Savings Plans (RESP): $70,000 among three children aged 11, 15 and 16
Commonly owned non-financial assets:
- family residence: $600,000
- in a building with four rental units: $860,000
Jointly held liabilities:
- mortgage loan on the house: $160,000
- mortgage on rental property: $450,000
The questions
Marthe and Noël are concerned about the imbalance in their balance sheet between their substantial real estate assets and their meager assets in long-term investment savings, such as for retirement in twenty years.
Marthe and Noël consider two scenarios which they submitted to The Press for consulting analysis.
First, explains Marthe: “Would it be financially and fiscally appropriate to use a line of credit that is still untouched up to $300,000 [et à taux d’intérêt variable approchant 6 %] to bail out our still very depleted RRSP and TFSA savings accounts? »
If yes, how to go about it? At what annualized rate? And according to which contribution priority between the RRSP and the TFSA?
If not, what solution should be explored?
Secondly, Marthe and Noël plan to resell the family home in order to move into two of the four units in their rental building.
Thus, describes Martha to The Press “We could use the net gain from the resale of the house [après les frais de transaction et le remboursement du solde hypothécaire] to replenish a good part of the contributions available in RRSPs and TFSAs. »
“We could, adds Marthe, finance the work of renovating two units into one in our rental building, which would then become a triplex with our family as the owner residing in the new large main housing. »
Marthe’s and Noël’s questions were submitted for analysis and advice to Julie Tremblay, who is a financial planner and investment savings product advisor at IG Wealth Management in Quebec City.
PHOTO ERICK LABBÉ, LE SOLEIL ARCHIVES
Julie Tremblay, Financial Planner and Advisor in Investment Savings Products at IG Wealth Management in Quebec City
Advice
Concerning the concern of Marthe and Noël about the bailout of their RRSP and TFSA accounts, Julie Tremblay suggests that they remedy it by using the technique known as “setting aside money” in personal finances.
“This technique aims to use the income from their rental property to boost their personal savings, starting with Marthe’s RRSP, in order to optimize tax credits during years of higher taxable income,” explains Ms.me Tremblay.
“As a counterweight, this ‘cash damming’ technique implies that Marthe and Noël would spend the building expenses in their still unused line of credit, the interest costs of which would then be deductible from the gross income of their building. »
According to Mme Tremblay, the advantage of this technique for Marthe and Noël is to be able to accelerate the replenishment of their unused RRSP contributions while optimizing the taxation of their employment income and their income from rental property.
By boosting their retirement savings with tax advantages, while completing the repayment of the mortgage loan on the family residence, Marthe and Noël could convert their debt on the house, which is devoid of tax advantages, into debt within a few years. additional tax on the rental property which is advantageous in terms of taxation thanks to the deductibility of interest in the gross income of the building.
Julie Tremblay, Financial Planner and Advisor in Investment Savings Products at IG Wealth Management in Quebec City
“Provided that Marthe and Noël use their line of credit only for building expenses, the after-tax net interest cost of this debt will actually be less than the contractual interest rate of around 6%”, summarizes Julie Tremblay.
Once Marthe’s RRSP has been fully contributed, and the mortgage on the family home is paid off, it may become relevant from a tax and financial perspective for Martha to consider contributing to her husband Noël’s RRSP.
Another solution, suggests M.me Tremblay, they could consider paying an income at Christmas for his work maintaining and managing the rental property.
“By increasing his Christmas taxable income in this way, it could become tax-efficient for him to contribute more to his RRSP. This is not currently the case due to its very low level of taxable income. »
As for Marthe’s and Noël’s TFSAs, which are still empty with nearly $160,000 in total contributions available, Julie Tremblay sees no priority there “as long as the couple concentrates their savings efforts on RRSPs, which are advantageous for reducing the couple’s taxable income.
In the meantime, advise Mr.me Tremblay, Marthe and Noël will have an interest in keeping their family residence, “because it’s the equivalent of a ‘super TFSA’, since the amount of the gain upon its eventual resale will be exempt from tax”.
Hence his final suggestion to Marthe and Noël to reconsider their plan to resell the family home in order to move into an enlarged and renovated apartment in their rental building.
“There are several financial and fiscal elements to consider carefully before carrying out such a project, without neglecting the risk of impacts on the style and quality of family life afterwards, warns Julie Tremblay.
“Among other things, going from investor owner to resident owner of a rental property involves several changes in the taxation of income and the gain in value of the building. There is also the risk of legal complications with the eviction of two of the four tenants on the grounds of repossessing their accommodation for the personal use of the owners and new residents. »
* Although the case highlighted in this section is real, the first names used are fictitious.
Are you planning a project that requires a wise use of your money? Do you have financial problems?