Should A Couple In Their 40s Buy Or Rent In Toronto To Afford Retirement?

Tony,* 45, and Rebecca,* 43, are recent transplants to Ontario from Alberta. Parents to a preschooler, they moved for their careers and have been renting while they get a better feel for their new home in the Greater Toronto Area.

Rebecca wants to buy, preferring to pay down their own mortgage instead of a landlord’s. Tony wants to rent, given the GTA’s high real estate prices and carrying costs of home ownership. Still, he sees Rebecca’s point. They agree that if they do buy, it will likely be a townhouse in the $700,000 to $800,000 range.

They plan to stay in Ontario at least until they retire, which they would like to do when they each turn 60. Their target income in retirement is $100,000 after tax. The couple’s current combined income is $210,000 before tax. If Tony retires in 15 years as planned he will receive $3,400 a month before tax from a previous employer’s defined benefits pension plan. He will also receive an income stream from his current employer’s defined contribution pension plan, but he is not sure how much it will be. Rebecca does not have an employer pension plan.

The couple own three self-sustaining rental properties in Calgary: a detached house (which was their primary residence until they moved); a semi-detached house and a two-bedroom condo, all carrying mortgages that should be paid off right around when they retire. Combined, the properties have an estimated value of $1,865,000.

The couple are considering three scenarios:

1. Keep all three rental properties and continue to rent in the GTA until they retire, anticipating monthly rental fees of about $3,000;
2. Sell all of the properties in Calgary and buy a home in the GTA;
3. Sell the condo, which hasn’t appreciated as much as the other properties, and buy in the GTA.

What are the pros and cons of each and which scenario will position them well for the future?

Tony and Rebecca have no desire to be landlords in Ontario and plan to open tax-free savings accounts to start building an investment portfolio. They are focused on growth and are looking into the broad range of exchange-traded funds . “I’d like guidance on what to consider, both in terms of ETFs and other investments,” said Tony.

The couple are also looking beyond retirement to ensure they are able to leave an estate for their young daughter. “Selling all of our properties means we lose a significant part of our retirement income. It would also reduce the inheritance we hope to leave our daughter, which would be of tremendous financial benefit to her.”

What the expert says

Tony and Rebecca are on track to retire in 15 years with $130,000 a year before tax ($30,000 more than their target retirement income), assuming their two rental properties in Calgary are paid off at that time and clear about $80,000 annually after expenses, said Ed Rempel, a fee-for-service financial planner, tax accountant and blogger.

“However, are they sure that will be enough and that their figures are accurate? Their desired lifestyle of $100,000 a year (about $85,000 after tax) is a huge drop from their current annual after-tax income of $155,000,” he said.

The couple also have not mentioned any savings or investments, other than the defined contribution pension plan transferred from an employer. “This suggests they are probably spending all their take-home pay today,” he said.

Rempel recommended verifying pension estimates and added that the defined benefit pension starting at age 60 will likely be reduced by the CPP offset at age 65.

When it comes to the couple’s three scenarios, Rempel immediately eliminated scenario 2: selling all three rental properties in Calgary and buying a home in the GTA for cash, leaving them mortgage free. This option would cost them an anticipated $80,000 a year in rental income in retirement – an amount much higher than they are likely to generate through investments, he said.

“Even if they invested $3,600 a month (the amount they otherwise would have paid in mortgage payments) in equity investments for the next 15 years, their anticipated $1.2 million portfolio and four per cent withdrawal rate would generate about $50,000 a year in income plus inflation for life. Keeping the rental properties is the better option.”

When it comes to renting versus buying and scenario 1 versus scenario 3, there are pros and cons to each.

“Buying a home for $750,000 with a downpayment of $100,000 from selling the Calgary condo results in a $650,000 mortgage. A 25-year mortgage would cost $3,600 a month plus property taxes, utilities and maintenance of between $1,000 and $1,500, putting the cost of owning close to $5,000 a month. This is $2,000 more a month than the anticipated $3,000 a month it would cost to rent the same property,” he said.

“If you invest that $2,000 a month in a conservative balanced investment making five per cent a year for 15 years, your investments should be about $530,000 when you retire. Based on a four per cent withdrawal rate, this should generate $21,000 a year in income plus inflation for life. If you invest in equities for more growth, your investments should be worth about $675,000 in 15 years and generate $27,000 a year plus inflation for life,” Rempel said.

However, even though real estate growth has dipped to just over three per cent a year over the past 10 years, a $750,000 home today with three per cent growth should be worth about $1.2 million in 15 years, said Rempel.

“The $650,000 mortgage would be down to about $350,000, so you should have equity of about $850,000. So from a net-worth perspective, scenario 3 is probably better. But, from a retirement income perspective, scenario 1 provides up to $27,000 a year in lifetime income rising by inflation. Scenario 3 provides no income unless you sell your home.”

In short, if the couple stay in Ontario, scenario 1 should provide a more comfortable retirement thanks to income from investments. However, if the couple sell and move back to Calgary, scenario 3 will provide more money for the move.

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Rempel’s advice: “Become comfortable with equity investments to get a more comfortable retirement. Equity investments have far higher long-term returns than real estate and can save tax in retirement. And when it comes to rental properties, when the mortgage is down to less than half the value of the property, it’s typically better to sell the property and invest the proceeds in equity investments. For example, the couple’s semi-detached property in Calgary is worth $625,000, growing at three per cent a year. If they sell it, the couple should clear at least $350,000, which they could then invest in equities returning an average eight per cent a year or more.”

*Names have been changed to protect privacy.

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