July 12, 2021 | Cookin’ it

Susan wants a kitchen. “My cabinets came on the Ark,” she says. “The dishwasher squirts and the countertops are made from some kind of hideous plastic. This reno is not an option.”

To pay for the big overhaul she needs about eighty grand. The good news is she can afford it. She and Todd currently have over $400,00 in their joint non-registered account (the only kind couples should set up together), plus the little house in Nanaimo is worth twice that amount, now debt-free.

“Make it happen,” she told her advisor.

But how? What’s the best way to pay for new appliances, tile flooring, fancy raw concrete counters and a killer hood fan unit? Do they harvest gains from the pandemic-pumped investment portfolio? Cash in non-performing assets? Borrow?

Well, here’s some stuff they need to consider…

First, leave the registered assets alone. RRSPs can’t be cashed in without adding the amount taken being added to annual taxable income, so that sucks. Besides, once you remove retirement savings money the contribution ‘room’ is gone forever. It cannot be replaced – unlike with a TFSA.

But raiding the tax-free account is also a bad long-term strategy. TFSAs are money machines. They should be fed fully each year, stuffed with growth ETFs and left to swell in all their tax-free bloating glory. The idea is to have as inflated an account as possible by retirement since the income stream it throws off isn’t counted as income and won’t push a retiree into a higher tax bracket nor bring a clawback of government pension pogey. This is not the place to go for a fancy oven, a trip to Cuba or a new Softail.

So what to sell, if the non-registered portfolio is raided? Funds that have leapt in value and created a nice capital gain, or fixed-income assets like a bond ETF that just sit there?

Well, remember balance. This might be a good time to rebalance an account that has overweighted on the growth side thanks to hyperventilated stock markets. It’s not the time to be lightening up on fixed-income stuff that might look unsexy and useless. That would remove some valuable portfolio insurance and cause pain when the next (inevitable) correction arrives.

As for harvesting capital gains, be aware of the tax. Half the profits are tax-free and the other half added to income (with a joint account that could possibly be split between you) and taxed at the personal marginal rate. So the highest cap gains rate would be a bit over 25%, but only 1%ers  pay that. For most people the rate is a modest 15%, which means you keep 85% of the growth.

But wait. There’s an election coming. Then a Trudeau romp. Then a budget. And more tax. Including, many fear, a hike in the capital gains tax inclusion rate (maybe to 75%). If that’s a possibility, Sue and Todd might be wise to take those cap gains in 2021 instead of waiting until Luigi and the boys can build the new eatery early next year.

Okay, so there’s another option. Borrow.

Maybe these people, with $800,000 equity in their home, would be smart to leave the investment portfolio in place and let the house finance its own kitchen. After all, that should increase the long-term worth of the real estate – basically paying for the reno with enhanced intrinsic value. Sound reasonable.

These days loans are still cheap. A home equity line of credit is available for prime plus a half point and a five-year mortgage is less than 2%. Given the fact financial assets have been growing at a double-digit rate in 2021 and even delivered more than 7% during tormented 2020, why cash some in when money is available at the rate of inflation? Huh?

Besides, if you borrow it’s maybe even possible to save tax. For example, pull a hundred grand out of home equity to put into the non-registered account, creating a tax-deductible borrowing. Then pay for the reno next year with portfolio money. The interest break stays in place. The borrowing is cheap and deductible. The long-term investments remain on the job, growing. The house is worth more. Sue gets her spiffy new kitchen.

Lesson: wealth brings more wealth. Life isn’t fair. Deal with it.

Garth Turner July 12th, 2021

Posted In: The Greater Fool

Next: Hoisington Q2 Quarterly Review and Outlook »