Can Tom and Marie travel the world on their line of credit for 10 years without running into financial trouble?
Open this photo in gallery Tom and Marie, both age 60, want to travel extensively for the next 10 years or more but they dont particularly want to sell their house. Christinne Muschi/The Globe and Mail  Wisdom has it you should pay off your mortgage before you retire from work, and for most people thats the prudent thing to do. Tom and Marie want to spend their house instead. We want to allow ourselves to splurge for the first 10 years while good health allows it, then slow down a little for the following years, Tom writes in an e-mail. Common wisdom suggests it is not a good idea to use debt to finance retirement expenses, Tom writes, but I am not sure I get the problem! Just retired, Marie and Tom, both age 60, have defined benefit pensions, investment assets of $1.4-million and a mortgage-free home in Quebec valued at $1.8-million. Story continues below advertisement  They want to travel extensively for the next 10 years or more but they dont particularly want to sell their house. Their retirement spending goal is $200,000 a year for the first few years, falling to $150,000 thereafter. Initially, without touching our RRSPs and TFSAs, we calculate that our [defined benefit pension] income will be $53,460 a year, Tom writes. They are entitled to collect Quebec Pension Plan benefits at age 65. To reach their spending target, they plan to use the $700,000 they have in short-term, readily cashable investments. This will cover our shortfall for the first five years, Tom writes. Afterwards, we will use our credit line instead of selling the house. They wisely set up the home equity line of credit  secured by a mortgage  before they retired from work. Our reasoning is that the house will increase in value at 5 per cent a year tax-free, much faster than the interest we will have to pay on the debt  2.5 per cent on the gradually increasing balance, he adds. they ask. What is the most tax-effective way to go about it?  We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Tom and Maries situation. What the expert says  The plan is indeed reasonable, Mr. MacKenzie says. Theyd have their house for another decade and any capital appreciation they might enjoy will be tax-free. If the house appreciates at the rate they hope it will, Tom and Marie would have had to make nearly 10 per cent in a private debt instrument to produce the same after-tax return, the planner says. Part of the reason this plan works for them is they are not concerned about leaving a large estate for their two adult children, Mr. MacKenzie says. Theyve already helped their children with the cost of their education and theyve taught them to be self-confident. Theyre not looking for more financial help.  Marie and Tom are better off than the average Canadian because they have indexed pension plans that, when combined with government benefits, their registered retirement savings plans and the eventual proceeds from their home sale, will be more than enough to live on, the planner says. They will be dipping into their capital, but that doesnt matter because they are not concerned about leaving an estate. By age 100 they will have used up most of their savings but theyll still have nice pensions, he says. As well, they have the flexibility and willingness to change course if it becomes necessary to do so. Story continues below advertisement  Marie and Toms basic plan is to spend as if their wealth was in the bank when in fact its tied up in the equity of their home, the planner says. When they exhaust their cash and liquid investments, they will borrow on their line of credit secured by the house. If interest rates rise or house prices languish, theyll switch gears and sell the property. Because they expect to live into their 90s, he suggests they consider delaying government benefits to age 70. With extensive travel, by the end of 2030 theyll have spent about $2-million on lifestyle and income tax, Mr. MacKenzie says. Of this total, about $500,000 will come from their pensions, $300,000 from Toms RRSP, their $700,000 in cash equivalents and about $500,000 on their line of credit. In 2032, when theyre both collecting government benefits on top of their work pensions, their total pension income will be about $115,000 a year (adjusted for inflation) and their net worth, excluding the estimated value of their pensions, will be about $2.4-million, the planner says. His forecast assumes an average annual rate of return on their investments of 4 per cent and an inflation rate of 2 per cent. For tax purposes, they should plan to split their pension income. However, because Marie has a higher defined benefit pension and Tom has a larger RRSP, income splitting is only going to be of marginal benefit, Mr. MacKenzie says. During the first 10 years of their retirement, Tom will have low taxable income, so he should turn a portion of his RRSP into a registered retirement income fund. He would withdraw sufficient income from the RRIF to bring his total taxable income up high enough so that he takes full advantage of the low federal and provincial tax rates that apply to the first $44,500 of taxable income, the planner says. If he does not do this, in the future, when he is collecting government benefits, hell be in a higher tax bracket because he will have a larger RRIF withdrawal, he adds. This may also mean that some of his Old Age Security will be clawed back, he adds. Tom and Maries combined investments total about $1.43-million. Of this total, about $850,000 is in cash and liquid investments. Most of their RRSPs and tax-free savings accounts are invested in stock-based exchange-traded funds. Given that the stock markets are near all-time highs and most of the cash investments will be needed within the next few years, having about 60 per cent of the entire portfolio in short-term investments makes sense, Mr. MacKenzie says. Story continues below advertisement  At some point in the future, when they cut back on their travel and their cash account has been spent, they should consider moving their registered accounts to a more balanced and diversified portfolio. Say theyve run up a $500,000 line of credit  about 25 per cent of their homes value in 10 years or so  but they dont have the cash to pay it off. Their credit line is backed by a mortgage, so presumably they could roll it into a mortgage. Interest only on a $500,000 mortgage at 5 per cent amortized over 25 years would be about $25,000 a year, the planner says. Payments to principal would increase that amount to more than $35,000 a year. Meanwhile, their income from their indexed pensions and government benefits would have risen to about $115,000 before tax. So homeowners using this strategy need to be sure they understand the potential risks. The plan: Go ahead and splurge. Their plan works so long as the house price is rising faster than the interest rate on the credit line. Story continues below advertisement  The payoff: With any luck, an enjoyable decade or so  and a comfortable retirement  Monthly net income: As needed  Assets: Cash $35,955; liquid investments $700,000; her RRSP $186,025; his RRSP $421,075; her TFSA $62,840; his TFSA $22,635; commuted value of their pensions $1.2-million; residence $1,824,000. Total: $4.45-million  Monthly outlays: Property tax $775; home insurance $265; heat, hydro $550; maintenance, garden $335; car lease $415; other transportation $350; grocery store $2,200; clothing $1,000; gifts, charity $600; travel $5,835; personal care $125; dining out $915; entertainment $400; sports, hobbies $250; health care $85; phone, TV, internet $210. E-mail finfacelift@gmail.com. Story continues below advertisement  Some details may be changed to protect the privacy of the persons profiled. Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.