The $200,000 Question: Renovations near Retirement
Balancing Taxes, Investments, and Borrowing
As Edi and Roy approached their retirement, they faced a common financial planning challenge: how to fund a $200,000 renovation to their home without derailing their carefully laid plans. With a healthy $3.5 million in assets split across joint non-registered accounts, TFSAs, RRSPs, and DC pension plans, they had several options. However, each choice came with trade-offs in terms of taxes, investment growth, and borrowing costs.
Here’s how they and their financial planner approached their “$200,000 Question” to find the best solution for their situation.
Step 1: Analyzing the Options
Edi and Roy had four potential funding sources:
1. Non-Registered Accounts
- $2.3 million in total, with $1.3 million in equities and $1 million in fixed-income and cash equivalents.
- Withdrawal of $150,000 from the equity portion would trigger realized capital gains of $90,000, split evenly between them.
- $50,000 would come from maturing GICs.
2. Tax-Free Savings Accounts (TFSAs)
- Worth $300,000 in total; fully funded since 2009.
- Tax-free withdrawals of $100,000 from each of their respective accounts were possible, with the ability to re-contribute withdrawn amounts starting the following year.
3. Borrowing via a Home Equity Line of Credit (HELOC)
- The best rate they could find for a HELOC was 6.45%.
- They want to repay the loan over five years, minimizing immediate financial strain.
4. Combination Strategy
- A mix of the above to balance tax implications, portfolio growth, and borrowing costs.
Step 2: Evaluating the Scenarios
To determine the most efficient option, they evaluated the long-term costs and benefits of each approach over five years. Here’s what they found:
Option 1: $200,000 from Non-Registered Accounts
Impact
- $150,000 withdrawn from equities, triggering $90,000 in realized capital gains.
- Combined taxable capital gains income: $45,000 ($22,500 each).
- Estimated Tax liability: $14,298.
Lost Growth
- Equities ($150,000 at 6.3%, after tax): $40,048.
- Fixed income ($50,000 at 4.0%): $10,833.
Net Cost
- Taxes and Lost Growth: -$65,179.
Option 2: $200,000 from TFSAs
Impact
- No immediate tax costs but lost tax-free compounding at 4.9%.
- Gradual re-contribution would partially recover growth over five years.
Lost Growth
- $200,000 at 4.9%: $53,827.
- Recovered growth through re-contributions: $22,000.
Net Cost
- Lost Growth = -$31,827.
Option 3: $200,000 Borrowed via HELOC
Impact
- Annual repayment over five years: approximately $48,674.
- Total interest paid: $32,250.
- Full portfolio remains invested, compounding at 4.9%.
Portfolio Growth
- $200,000 at 4.9%: $53,827.
Net Gain
- Portfolio Growth – HELOC Interest = $21,577.
Step 3: Finding the Best Solution
The planner’s analysis revealed that borrowing via a HELOC was the most efficient choice for Edi and Roy:
Preserving Portfolio Growth
By keeping their assets fully invested, they allowed their portfolio to continue compounding, which offset a significant portion of the borrowing cost.
Minimizing Taxes
Unlike non-registered withdrawals, the HELOC avoided immediate tax consequences.
Flexibility
HELOC payments were manageable within their retirement budget and allowed them to spread out costs without disrupting their long-term financial goals.
Their planner had also suggested they consider the option of a combination approach:
- Use $50,000 from maturing GICs (minimizing tax impacts).
- Withdraw $50,000 from TFSAs (tax-free).
- Borrow $100,000 via a HELOC to spread costs efficiently.
This hybrid strategy attempts to balance taxes, growth, and borrowing costs while maintaining liquidity and flexibility. However, it still results in lost interest income from the GICs of $10,833, a net loss of growth from the TFSAs of $8,597, and interest charges of approximately $17,424 on repaying the HELOC over five years.
Net Cost
Lost GIC Interest and TFSA Growth plus HELOC Interest = -$36,854.
The Bigger Picture
Edi and Roy’s decision demonstrates the importance of carefully evaluating all financial options, particularly during retirement. Taxes, opportunity costs, and borrowing rates all play critical roles in optimizing wealth management.
While their $200,000 renovation may seem like a significant expense, with proper planning, they were able to fund it without compromising their long-term goals. And that’s the real value of thoughtful financial planning: helping you to make confident decisions while enjoying the retirement you’ve worked hard to achieve.
Your Turn
If you’re facing a significant financial decision—whether it’s a large transaction, a major milestone like retirement, or anything in between—having a conversation with a financial planner can help clarify your options and provide guidance for your particular situation. It’s worth considering how professional advice can support you as you navigate these important steps.
This is the 269th blog post for Russ Writes, first published on 2024-11-18
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.