If she retires at 62, Melanie will be entitled to a lifetime pension of $43,800 a year plus a bridge benefit of $11,580 a year ending at age 65.Ashley Fraser/The Globe and Mail
Melanie is 56 years old and on her own again with two adult children, a government job, a house with a big mortgage and an investment property that generates net rental income of about $5,900 a year after expenses. She immigrated to Canada from Eastern Europe 20 years ago.
“I successfully launched two kids on my own plus sponsored my mom for 10 years,” Melanie writes in an e-mail. She bought a house a couple of years ago after she and her ex-husband separated. “In addition, I provided both kids with loans, so they bought their own condos.”
Having had a brush with serious illness, Melanie wonders if she can afford to retire from her $109,400-a-year job at age 62 or if she should continue to age 65. She wants to stay in her home as long as possible. Her goal is to maintain her standard of living and increase her travel budget, so she’d need about $60,000 a year after tax adjusted for inflation.
If she retires at 62, Melanie will be entitled to a lifetime pension of $43,800 a year plus a bridge benefit of $11,580 a year ending at age 65. If she works to 65, she’ll get a lifetime pension of about $53,000 a year.
A few years ago, Melanie made a money-losing investment through a corporation of which she is the sole owner. Now, she wonders if she can use some of that corporate loss to offset the capital gain on the eventual sale of her rental property or even to offset the tax paid on her employment income.
We asked Warren MacKenzie, an independent Toronto financial planner, to look at Melanie’s situation. Mr. MacKenzie holds the chartered professional accountant designation.
What the Expert Says
A number of years ago, Melanie had $500,000 in savings “before making the mistake of investing it all, through a holding company, in a foreign startup venture that failed,” Mr. MacKenzie says.
Melanie wonders if she can deduct the resulting capital loss as an allowable business investment loss (ABIL) against her other income, the planner says. The answer is no. “To be deductible against other income, the ABIL must have occurred in Canada. Because her company invested in a non-Canadian venture, she will not be able to deduct the loss from her other income.”
As well, Melanie hopes that she can use the corporation’s capital loss to offset the accrued capital gain of about $200,000, which will be triggered when she sells her rental property. Netting as much as possible from the sale of the rental is critical if she hopes to retire a bit early, Mr. MacKenzie says. That’s because Melanie doesn’t have much in the way of financial assets to supplement her pension.
She could get a benefit from the corporation’s loss carry forward by using Canada Revenue Agency Section 85 rollover provisions, the planner says. Section 85 would allow her to transfer ownership of her rental property to the holding company in exchange for preferred shares, he says.
She should work with her accountant to maximize her tax deductions and recover as much as possible of the potential tax benefit.
“By using the Section 85 rollover provisions, the transfer of the rental property would not be deemed to be a sale of the property and therefore no personal capital gain would be triggered,” the planner says. “Later, when the holding company sells the rental property, Melanie would be able to collect the net proceeds of the sale by redeeming her preferred shares. Any capital gain would be offset by the existing $500,000 capital loss carry forward, so tax would be minimized or completely avoided.”
She could use the money from the sale to pay down the mortgage on her principal residence. “To simplify her life and have funds to pay down her personal mortgage, the projections assume the holding company will sell the rental property in 2025,” the planner says. His projections are based on an inflation rate of 2 per cent and an average rate of return on investments of 5 per cent.
Because of her health scare, Melanie has asked that the planner assume a life expectancy of 87 years.
If Melanie retires at age 62, her cash outflow will be about $83,000 a year, adjusted for inflation. That includes her basic spending, a renewed mortgage with an extended term, a larger travel budget and income tax.
This outflow will be covered by her work pension of $43,780 a year plus a bridge benefit of $11,580 to age 65, a carbon tax rebate of $590 and a projected draw of $27,000 a year on a line of credit or reverse mortgage on her house. With inflation, her home would be valued at about $1,250,000 by the time she was 62, and with a mortgage of about $200,000 at that time, she should be able to get a reverse mortgage. The company offering the reverse mortgage would pay off the existing mortgage.
Melanie would begin taking Canada Pension Plan and Old Age Security benefits when she is 65.
If, in contrast, she works to age 65, her spending will be about $94,000 a year, adjusted for inflation – $54,000 for basic expenses, $15,000 for income tax, $13,000 for mortgage payments and $12,000 for vacations.
Her lifetime pension would be $53,045 a year, about $9,000 a year more than if she retires at 62. In addition, she’d get Canada Pension Plan benefits of $9,900 a year, Old Age Security of about $7,000, and a carbon tax credit of $615, for a total of slightly more than $70,000 a year before tax. Again, the shortfall would be covered by borrowing against the equity in her home.
By working three more years, she would earn another $360,000 or so in salary. By contributing to her work pension and Canada Pension Plan for three more years, she would enjoy higher pension benefits for life.
“If she lives to be 87, she would have 22 years of higher pensions. Ignoring the pension increases due to inflation, that would be another $330,000 of pension income,” the planner says. “With some extra investment income, by working an additional three years, Melanie could earn about $700,000 more over the rest of her life,” Mr. MacKenzie says. After tax, the net benefit to working three more years could be about $500,000.
“The projections show that if everything goes right, it’s possible she could retire at age 62,” the planner says. “But projections of more than 30 years never work out exactly as planned, so there’s a higher probability of Melanie achieving all her goals if she works until age 65.”
Client Situation
The Person: Melanie, 56.
The Problem: Can she use her corporate tax losses to benefit her financial situation? Can she afford to retire at age 62?
The Plan: Prepare to work to age 65 if necessary. Consult her accountant about rolling the investment rental property into her corporation so her corporate loss might offset the potential capital gain on the sale of that property.
The Payoff: A better understanding of where she stands financially.
Monthly net income: $7,495
Assets: Tax-free savings account $9,500; RRSP $27,000; residence $1,000,000; rental property $400,000. Total: $1,436,500.
Commuted value of Melanie’s pension at age 65: $1,100,000.
Monthly outlays: Mortgage $2,440; property tax $575; water, sewer, garbage $50; home insurance $100; electricity $95; heating $110; maintenance $250; transportation $410; groceries $650; clothing $100; car and personal loans $760; vacation, travel $500; dining, drinks, entertainment $150; personal care $50; club memberships $80; sports, hobbies $100; subscriptions $10; accountant $140; health care $100; phones, TV, internet $90; TFSA $100; pension plan contributions $865. Total: $7,725.
Liabilities: Residence mortgage $475,000 at 3.51 per cent; rental mortgage $153,000 at 2.99 per cent; home renovation loan $4,000; car loan $8,000. Total: $640,000.
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