Should Frank and Michelle pay off the mortgage on the house using some of the money from her purchase of a half-share in the residence?

Frank and Michelle are planning to marry soon, merging their finances to some extent while being mindful of the interests of their four children. Frank is age 75, and Michelle is 72.

They are each getting Canada Pension Plan and Old Age Security benefits and drawing from their registered retirement income funds (RRIFs). Michelle also gets 60 percent of her late husband’s defined benefit pension.

To avoid misunderstandings, their lawyers are drawing up a cohabitation agreement. Michelle plans to put her B.C. home up for sale and use some of the proceeds to buy a half-share of Frank’s residence. Frank wonders whether they should use some of the proceeds to pay off their mortgage. As well, they want to give a cash gift to their children.

They have two main questions: Can they preserve most of their estates for their heirs and still have enough cash flow to take $20,000 trips each year for the next five years? “Can we gift up to $400,000 to our children in the next two or three years?”

Their retirement spending goal is $100,000 a year after tax.

We asked Warren MacKenzie, head of financial planning at Optimize Wealth Management in Toronto, to look at Frank and Michelle’s situation. Mr. MacKenzie holds the chartered professional accountant (CPA) and certified financial planner (CFP) designations.

What the expert says

Frank and Michelle have managed their money wisely, Mr. MacKenzie says. Between them, they have a net worth of about $ 5 million.

As they start their new relationship, Frank and Michelle want to know how much they can safely spend each year, and how large an “inheritance advance” they can give to their children. “These are common questions, and most retirees will enjoy a happier retirement when they have a financial plan that answers them,” the planner says.

Mr. MacKenzie’s forecast shows that if they live to be 100, and spend at the desired level of $100,000 per year, they’ll still be able to leave each of their children more than $ 1 million in dollars with today’s purchasing power. That assumes average annual investment returns of 5 percent and inflation of 2 percent.

“This is after giving their children a gift of $100,000 each over the next two years,” the planner says. They could increase their spending by 50 percent to $150,000 per year and still leave their children a substantial inheritance, he says. “They are not concerned about the possibility of needing an expensive retirement home because if and when the time comes, they plan to fund the expense by selling the family home,” valued now at $2.1-million.

Frank and Michelle have both lost their spouses in the past few years, the planner notes. Perhaps this is why they both list avoiding legal complications in the administration of their estate as another important goal. “One thing that will be key to avoiding future complications and conflict will be for open communication and full transparency about the terms of their wills,” Mr. MacKenzie says.

Frank and Michelle are bringing roughly equal assets into their second marriage, sharing the house they will live in. They will be tenants in common, meaning they will share ownership of the house with each one’s share passing to that person’s estate when they die. Their heirs naturally will want to see that their parents’ assets will be distributed fairly when they eventually pass away.

When there is a substantial estate, and a blended family with four children plus sons - and daughters-in-law, there is always the possibility of conflict, the planner says. “Disagreements that can tear a family apart.”

To minimize the potential for conflict, Frank and Michelle should consider appointing a corporate executor rather than any of their children.

Gifting some money to the children now is a sensible strategy for several reasons, the planner says. Their children likely would prefer the money now rather than in the future, he notes. As well, a gift will reduce the size of the estate, perhaps reducing the potential for disputes. It will also allow the parents to enjoy seeing the good that their money can do. In addition, by gifting non-registered capital to their children, Frank and Michelle will reduce their own taxable income from investments and reduce the possibility of a claw-back of Old Age Security benefits.

In 2023, their combined income from CPP, OAS, Michelle’s survivor pension, and minimum RRIF withdrawals will be about $116,000 a year, Mr. MacKenzie says. Spending and income tax will be about $136,000. “So in order to make ends meet, they’ll need cash of $20,000 from their non-registered investment portfolios,” he says. After gifts to the children, and paying off their mortgage and line of credit, their non-registered portfolios will total more than $1,500,000. This level of capital should generate more than sufficient interest and dividend income to cover their needs, the planner says.

Frank and Michelle are experienced do-it-yourself investors, the planner notes. “For the past 30 years they have been following a buy-and-hold investment strategy that has worked out well for them,” he says.

Now that they are retired and in their 70s, it’s time to simplify their portfolios and shift to a more conservative investment strategy, Mr. MacKenzie says. Their current asset mix is about 80 percent stocks and about 20 percent cash and fixed income. “They should consider reducing their exposure to equities to 40 or 50 percent of the total portfolio,” the planner says. When stock prices move above or below the target allocation, they should rebalance the portfolio back to the target asset mix. “They are taking more stock market risk than is necessary to maintain their lifestyle and also leave a substantial estate.”

From a tax planning point of view, since Michelle has her late husband’s DB pension and a larger RRIF, they should split their pension and RRIF income, the planner says. This will mean more income will be taxed at Frank’s lower marginal tax rate, reducing the potential for the clawing back of Michelle’s OAS benefits.

Frank has unused TFSA contribution room. When Michelle buys into Frank’s house, they should use some of the proceeds to maximize his TSFA contributions, Mr. MacKenzie says. Frank wonders whether they should also use some of the proceeds to pay off the mortgage on the home they will share. “It makes sense to pay off the mortgage because while the current interest rate is low, it is a non-tax-deductible expense,” he says. As well, the interest rate will likely be much higher when the mortgage is renewed in about two years.

Client situation

The People: Frank, 75, Michelle, 72, and their adult children.

The Problem: Can they travel extensively for five years without depleting too much of their estate?

The Plan: Go ahead and gift the money to the children. Be open and transparent about their estate planning. Pay off the mortgage and move to a more conservative investment strategy.

The Payoff: The lifestyle they want as they set out on their new life together.

Monthly net income: $14,920 or as needed.

Assets: Cash $5,000; her stocks $405,000; his stocks $65,000; her RRIF $487,000; his RRIF $211,675; her residence $1,500,000; his residence $2,100,000; her cottage $400,000; estimated present value of her late husband’s DB pension $400,000. Total: $5,573,675.

Monthly outlays: Mortgage $2,200; water, sewer, garbage $75; home insurance $75; heating $50; maintenance, garden $100; transportation $450; groceries $600; clothing $225; line of credit $100; vehicle debt $550; gifts, charity $800; vacation, travel $2,000; other discretionary $100; dining, drinks, entertainment $500; personal care $100; club memberships $300; sports, hobbies $300; subscriptions $50; health care $225; communications $285. Total: $9,085.

Liabilities: Residence mortgage $495,000; line of credit $25,000; other loans $24,000. Total: $544,000.