When it comes time to sell the family home to provide the cash for retirement home living, just what should a person do? I'm no financial expert, but I came across an interesting article from Garth Turner that provides some advice on this topic.
Garth Turner's article....
At 78 she was forgetting her kids’ names, using a walker, and almost microwaved the cat. So the family decided it was time to sell mom’s house and stick her in a nice retirement home. The trouble with that: mom had no income save the public pension plan pittance, and the new digs cost three grand a month.
But once the house deal closed, there was $400,000 to play with. And that’s when armed conflict broke out.
Mother wanted to stick it in GICs because that’s what TNL@TB had told her. And she’d always listened to her in the past. But four hundred large invested in a five-year GIC paying 2.3% would give just $760 a month. Actually, it would return nothing at all until maturity, meaning the kids would have to upfront things. Nix that.
One of the sons pushed for mutual funds (he sells them), but everybody else figured out pretty fast his trailer fee might be bigger each year than mom’s cash flow. Screw that.
Then a daughter hooked up with an insurance guy who proposed a sweet deal. Give me the $400,000, he said, and I will guarantee you (did you hear that word, ‘guarantee’?) monthly payments of $3,500 every four weeks for the next ten years. Best of all, he continued, there will be no tax payable on this income stream, which means the old lady gets taken care of, with enough cash left to have Jack Daniels visit regularly.
And that’s what they did. They took the annuity. Nobody could imagine, after all, that she’d live more than the ten years.
This is a small but fine example of how people get skanked. The insurance company, of course, just took the money and then agreed to hand it back in 120 installments. Those $3,500 monthly payments add up to $420,000 over a decade – which is a 1% return on $400,000 (the exact amount is $418,140). Meanwhile, you can be sure they gave out the four hundred as a loan or mortgage at four times the rate.
Why would anyone possibly agree to hand their money over so it can be handed back? Because it seems safe. It’s predictable. It’s guaranteed. And most people are fools.
This, of course, is also why we buy guaranteed investment certificates and put our TFSA money into ‘high-yield’ savings accounts paying less than inflation. Let’s face it. Most Canadians haven’t a clue about investing, which is why they’re road kill for mutual fund salesguys and ravenous bank employees.
A few days ago I gave you a small primer on bonds. I showed you how they not only pay regular interest and guarantee your principal, but are capable of coughing up a nice capital gain – like during this past week.
More on that soon. You should also know about preferred shares. I’ve written about these things here often in the past, but it’s time for a review. That is, if you’re interested in making 300% more than with a GIC, at low levels of risk, while paying 80% less tax.
Preferred shares are more like bonds than stocks. Companies issue them to raise capital (same as bonds) and then pay the owners a regular stream of income so long as they own the preferreds. With bonds, the stream is called interest. All the interest you earn – 100% of it – is taxable (as with a GIC). But preferred shares pay you in the form of dividends, which are taxed far less. Point one.
Companies also issue common stocks, which we call ‘equities’, trading on places like Bay Street and Wall Street. Corporations like to keep shareholders happy by giving them a share of the profits. But these dividends can fluctuate significantly depending on the business cycle and the profitability of the company. Not so with preferred shares. Their dividends must be paid before any money goes to common shareholders. Better still, the dividend does not fluctuate. It’s fixed. Point two.
The preferred shares I like the most are the ones issued by the bedrocks of the financial system – Canadian banks and insurers (regulated companies like utilities are also cool). So it’s ironic that you can go and give a major bank your life savings and the GIC they place it in will yield 2%, and be illiquid until the day it matures. Or you can buy preferred shares in the same bank, and collect a dividend of 5.35%, which is paid to you regularly, while the shares themselves are 100% liquid – they can be sold in minutes. Point three.
By the way, if you’re in the middle federal tax bracket and earn $5,000, your tax bill is $1,100 if the income comes as interest, but just $217.50 if as dividends from preferreds. This means a dividend paying you 5.35% would be roughly equivalent to a GIC yielding 6.5%. And have you seen any of those lately? That are cashable?
What are the downsides? If interest rates rise then the price of preferreds (as with bonds) declines. But, of course, the income stream continues – so most people don’t get too fussed about that, especially when rate increases are likely to be gentle. And if we have another financial meltdown, then preferred values will also decline along with everything else – but the income will carry on. We had a chance to witness this in 2008-9, and bank preferreds bounced back in price quickly. By the way, not a single bank missed a single dividend payment. Investors who counted on income, not capital gains, never noticed a thing.
So, if mom’s $400,000 had been put into the preferreds of a few banks, she’d pay for her digs ($36,000 a year) and still have $200,000 left a decade later.
This is why children are so overrated.
( The above article is from Garth Turner at http://www.greaterfool.ca/ )
Garth Turner
Read what others had to say about this in the comment section of Garth Turner's greaterfool website .
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