Can Carlos and Paula still afford a cottage if they give their kids proceeds from the sale of their home?

Carlos and Paula ask if they can afford to sell their family home in Montreal, give each of their children $300,000, move into a city rental apartment and buy a cottage in the country.

Carlos is 69 years old and Paula is 62. Their two children are 29 and 30.

They both have defined benefit pensions. Their pension income and Carlos’s government benefits add up to $107,900 a year before tax. Their house is valued at $1.2-million.

“We want to sell the house to our son and his partner, but they are unable to take this on right now,” Carlos writes in an e-mail. The plan is to sell to their son at a price below market – $900,000 – in about three years. “We would give an equivalent amount to our daughter.”

Would the $600,000 the couple would have left be enough to buy a cottage in the country and rent an apartment in the city? Carlos also asks: “Are there other scenarios you can propose?”

We asked Anna Golan-Reznick, a certified financial planner at Objective Financial Partners Inc. of Markham, Ont., to look at Carlos and Paula’s situation. Objective is an advice-only financial planning firm.

What the Expert Says

Short term, Carlos and Paula can comfortably meet their goals, which include remaining in a paid-off home for the next three years, travelling and volunteering abroad, Ms. Golan-Reznick says. Their desired after-tax spending goal is $80,000 a year, which leaves some room for emergencies, the planner says.

Carlos and Paula have an additional annual cash flow surplus of $7,000 to $8,000 that could be directed to their tax-free savings accounts. This surplus will increase when Paula starts collecting government benefits and they both start making withdrawals from their registered retirement income funds (RRIFs). “They appear to have more after-tax income than expenses. This definitely helps with their gifting plans,” the planner says.

Longer term, they plan to sell the house, valued at $1.2-million, to their son for $900,000. The difference of $300,000 would represent a gift, so the couple would give an equivalent amount to their daughter. That would leave them with $600,000, which could be used to buy a small cottage in the country for $400,000 and for renting an apartment in Montreal.

Ideally, the interest from the remaining sale proceeds would be sufficient to finance rent on an apartment over the next several years.

“We assume that upon the sale of the house in 2028, the couple would rent for about $3,000 a month,” Ms. Golan-Reznick says.

In preparing her forecast, the planner used the following assumptions: A rate of return for Carlos’s RRSP and TFSA of 4.68 per cent, based on a portfolio split of 52 per cent equity and 48 per cent fixed income. For Paula’s RRSP, a rate of 5.19 per cent based on 68 per cent equity and 32 per cent fixed income. Inflation, including real estate price appreciation, averages 2.5 per cent.

Carlos’s defined benefit pension is indexed to inflation, while Paula’s is only partly indexed. The planner assumes a conservative 0.5 per cent cost of living adjustment for Paula’s pension.

It is assumed they convert their RRSPs to RRIFs at age 71 and that they both live to be 95 years old.

“Based on our projections, if the couple opts to rent a small residential unit and purchase a cottage, there is likely to be a shortfall in cash flow, especially if Carlos were to die before Paula,” the planner says.

That assumes the money they are left with – about $186,000 after fees – would be deposited to the couple’s TFSAs and a joint non-registered account with a rate of return of 4.68 per cent. “This does not provide much of a buffer to protect against long-term care costs or Carlos dying long before Paula,” Ms. Golan-Reznick says.

The shortfall would start in 2051, one year after Carlos’s life expectancy of age 95. It would be magnified by the fact Paula would have to rely only on her income sources; all the investment accounts would be depleted. Even if she were to sell the cottage following Carlos’s death, she would still need to reduce her expenses by about 10 per cent.

The planner looks at an alternative scenario, in which Carlos and Paula buy a city apartment for $600,000 and rent a country place during the summer.

In preparing her forecast, the planner kept annual expenses the same to cover condo fees, which offset potential property tax savings. She has assumed the rental for three months in the summer would be $9,000.

“In this scenario, all the proceeds from the sale of the house would be allocated within the year of sale for gifts and the purchase of a condo,” Ms. Golan-Reznick says. In the years that follow, there will be a sufficient cash flow surplus to cover a summer cottage rental and additional TFSA contributions.

“Based on our projections, the total estate value at Paula’s age 95 is nearly $1.9-million.”

Carlos and Paula could consider gifting in stages. “The $600,000 that they are planning to gift is significant relative to their net worth so early in retirement,” Ms. Golan-Reznick says. They could, for example, gift a total of $300,000 to their two children from their downsize proceeds and reconsider another $300,000 in five years.

Selling the house below market value and gifting the difference to the son has no tax implications for the parents due to their principal residence exemption. However, their son would receive the house at an adjusted cost base of $900,000 instead of its $1.2-million market value. “This could potentially increase his future tax liability if he doesn’t use it as his primary residence for all subsequent years or if tax rules change,” the planner says. “It’s recommended to clearly specify the sale and gift percentages (such as 75 per cent sale, 25 per cent gift) in the purchase agreement,” she adds.

Finally, Paula should consider deferring her Quebec Pension Plan and Old Age Security benefits to as late as age 70 if her health remains good, Ms. Golan-Reznick says. “This can mitigate against the risk of her living a long life and Carlos dying young.”

Client Situation

The people: Carlos, 69, Paula, 62, and their two children.

The problem: Does it make sense for them to gift a big part of the proceeds of their house sale to their two children? If they do, can they still afford a place in the city and a cottage as well?

The plan: Consider buying a city condo and renting a cottage for the summer. Consider selling outright and giving each child $300,000, perhaps in two instalments.

The payoff: Leaving Paula on a more secure financial footing in case Carlos, who is seven years older, dies well before she does.

Monthly net income: $7,345.

Assets: Cash $10,000; his TFSA $50,000; his RRSP $375,800; her RRSP $244,000; residence $1,200,000 Total: $1,879,800.

Estimated present value of his pension $501,150; estimated value of her pension $1,027,650. This is what someone with no pension would have to save to generate the same income.

Monthly outlays: Property tax $665; water heater, gas for stove $50; home insurance $90; electricity, heating $155; security $30; maintenance $420; garden $40; transportation (car share, parking) $260; groceries $1,200; clothing $165; gifts, charity $275; vacation, travel $835; dining, drinks, entertainment $1,090; personal care $100; sports, hobbies $165; subscriptions $100; health care $155; health and dental insurance $255; phones, TV, internet $280. Total: $6,330.

Liabilities: None.

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