What You Should Know About Real Estate As A Retirement Plan, And Why RRSPs Can Fail You.
By: Sarah Colucci, Mortgage Expert
Why Invest Anyways?
We define an investment as the action or process of investing money for profit or material result. There are many investments an individual can partake in, some being more lucrative than others. Not all investments are equal. Some pose more of a risk, which is why a person who wants to invest in various assets needs to ensure they truly understand and appreciate their personal risk tolerance level.
A risk, specifically a financial risk, is an action that could cause monetary loss. Some investments, while they can churn an attractive profit, can also trigger a huge financial setback. Therefore, an investor needs to determine how much he or she can afford to lose and take measures to ensure they mitigate financial loss the best way they know how when investing. It’s the “mitigation” part of investing that often requires the help of professionals like real estate experts, lawyers, stockbrokers, financial advisors and so on - investing without knowledge or experience in any area can be dangerous for anyone who does so.
At the banking level, there are only a few stealthy bankers who advocate for and encourage building a real estate investment portfolio. Mostly, investments such as mutual funds and RRSPs are the preferred product of choice sold throughout the commercial banking sector, regardless of an individual gaining substantial benefits or not. This is also why many people have minimal RRSPs and Mutual Fund investments instead of or besides sizeable real estate assets.
Let’s think about an RRSP.
An RRSP is a Registered Retirement Savings Plan. It’s a financial account for holding savings and investment assets. RRSPs have various tax advantages compared to investing outside of tax-preferred accounts.
What are the main advantages of RRSPs?
For most people, it’s tax write-offs at the end of the year. But, if someone’s income bracket is not high enough, where they pay a substantial amount of their income to taxes, the benefit of the yearly tax refund deteriorates. If an individual gets taxed at 50 percent of their income, for example, investing in RRSPs is more helpful in producing a larger tax refund than someone who gets taxed at 15 percent. Yet, ironically, those in smaller tax brackets still get sold the RRSP and are told it’s the best financial product of a lifetime - a concept full of flaws. The financial institution then locks away a person’s money until they retire and if they dare try to access those funds before then, it will require them to pay punitive taxes as a penalty.
The idea with RRSP investments is that after retirement, although the funds saved away will get taxed as income, a pensioner will not require a large living allowance. Obviously, a 65-year-old will not want to travel, indulge and live an extravagant life. He or she will be fine earning 35 percent of their previous income. Or is this the case at all?
Different people will want different experiences after retirement and therefore, will require a differing amount of yearly income. Therefore, investing in RRSPs is not universally imperative. It also definitely should NOT be the sole investment someone directs their money into over their lifetime.
What about real estate?
Again, here we talk about risks. What are the risks involved in investing in real estate, specifically purchasing rental properties? Like RRSPs, we also consider real estate a low-to-moderate risk.
The obvious risks (there are others, though not as significant) are tenants not paying the mortgage (if there is one), and property value degrading along with it being worth less than the outstanding mortgage balance, which can pose an issue if the landlord needs to sell quickly. What are the chances of this happening? Not likely. The power of sale rate in Canada is less than 1% and the mortgage default rate is also negligible.
Therefore, real estate can be a retirement plan for those that own property for the long term which means “real estate for retirement” excludes “property flippers” who want to renovate to churn a quick profit. It’s important to keep that in mind. Holding real estate is a long-term investment.
The Logistics of Real Estate Investing
If an investor requires a mortgage to purchase a rental property, then initially, the rental income generated on that property will get allocated to the mortgage payment. The rental payments, in theory, should always take care of the property’s expenses such as the mortgage principal and interest payment, property taxes and so on. In a perfect world, nothing should come out of the owner’s pocket and in fact, he or she should cash-flow on a monthly basis.
With the right financial plan, the property’s mortgage can get paid off in just fifteen years, leaving behind an excellent source of rental income as a monthly cash flow for years to come before and after retirement.
And that’s not all.
When the mortgage gets paid off, partially or in full, equity becomes available. Equity is of utmost importance in the game of investing and in the simultaneous endeavour of creating a comfortable lifestyle; one that doesn’t require labour before and after retirement. Having more equity means having more value and more capital available. Having more capital opens up more opportunities to engage in further investments, further cash flow opportunities, and so on.
Therefore, is an RRSP more superior to real estate? Why not have both?
More importantly, why not engineer a retirement you desire?
Sarah A. Colucci, Mortgage Agent, Lic. M14000929
Mortgage Edge, Broker 10680
Direct: (647) 773-4849
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By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929