Monday, 24 October 2016

Beyond RESP, Boomerang Kids, Home Ownership and Wealth Transfer

Let’s say your children have finished university, found a job in their field of study and are still living at home because …… they can not afford to rent an apartment in the city (of Toronto), or have not even thought about saving for a down payment on a house.  Between paying off study loan and living the good life that Gen Ys are used to these days, it is no small wonder that the Bank of Mom and Dad has to come to the rescue when it comes to home ownership.  Do not despair as you may wish to continue reading on.

There was a recent report published by CIBC that indicated there is approximately $750 billion to be inherited by Canadian baby boomers between the ages 50 to 75. On average, one can expect to inherit $180,000 in the next ten years. This will represent the largest intergenerational wealth transfer in Canadian history. In part, this holds true for mostly GTA-ians (Greater Toronto Area) as well as people living in the Vancouver area due to the soaring real estate prices. Homes and cottages purchased in these areas in the 1960s for $50,000 are now valued in excess of $1 million to $2 million.

In addition, inheritance from life insurance also form a vital part of the wealth transfer. Both the gains from sale of principal residence and proceeds from life insurance are also tax-free.

As a life insurance professional as well as a recently qualified financial planner, I have witnessed such transfers on numerous occasions , especially when attending funerals of close friends and relatives.  Most of the dearly departed (blessed their souls) have left on average their principal residence to their children as well as designated their children as beneficiaries on their life insurance policies.

With this new found wealth, and with the fact that most baby boomers are already well on their way to retirement or their planned retirement, the next best thing for them to do is help out their children own a home.  True, the $180,000 average inheritance will not even qualify as a 20% down payment on a home in the cities these days, but owning a new build condominium can be the next best alternative.  

Consider the following scenario:
Purchase price of an average 1-bedroom condo in Toronto: $300,000

Completion date: 2-3 years

Average down payment required in the first year: 10% or $30,000 which the Bank and Mom and Dad fronts

Average Mortgage: $270,000

Rate: 4.64% (based on the 5-year fixed rate, new rules effective October 17, 2016)

Monthly Mortgage Payment: $1,522 before Property Tax and Maintenance Fees

Assume that in 2 years’ time prior to moving in, your child has also saved another 10% or $30,000, one can avoid having to pay mortgage insurance.

Also assume that on average, the condominium has appreciated 5% annually over 2 years (this is totally realistic considering the state of the housing market in GTA and Vancouver). In fact, real state has also proven to be a good hedge against inflation.

The same $300,000 pre-build condominium purchased is now worth $330,750.

Recall, the initial $30,000 down payment has now resulted in an additional  return of $30,750 or 102.5% due to leverage.

Try doing the math yourself if you are unsure.  Is this not the best thing you can do for your children?

Disclaimer: I believe the above assumptions are totally realistic as most people I talked to are fed up with anemic stock returns and are putting their money in something more tangible. The only people making above average returns on stocks are either insiders who have privy knowledge, senior management  getting stock options for hardly doing anything, or the banks touting these stocks to innocent investors. Don’t get me wrong, there are still a lot of great companies out there worth investing, but one has to look beyond just stocks! 

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