DEBT CLOUDS DREAMS OF RETIREMENT AT 60

A British Columbia management consultant we’ll call Patricia, 53, has two children and a six-figure annual take home income. She ought to be affluent, but feels far from it. She has a net worth of $525,443 including a heavily mortgaged rental property that generates a paltry return, a house, two cars and a fishing boat. It’s not a lot to show for three decades of work.

“I have never been very good with money,” Patricia admits. “I have always managed to spend up to the level I earn. Can I realistically plan to retire at age 60?”

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Patricia.

“She has a challenge to maintain her way of life when she quits her job and retires,” Moran says. “Her expenses are huge, among them $7,635 a month for two mortgages, a car loan, a house renovation loan, a boat loan, line of credit and child support paid to her ex-spouse. There are other costs, too. There is not enough time to save for a sixfigure retirement income.

EVALUATING EXPENSES

Patricia has a 17-year-old child who has $32,279 in an RESP. She can continue to add money, but this is the last year for the Canada Education Savings Grant, which contributes the lesser of $500 or 20 per cent of annual contributions. Next year, she can cut her present $4,200 annual RESP contributions to $2,500, for annual savings of $1,700. The older child will have about $36,000 for university. Her younger child, 10, has $25,706 in an RESP and could have $55,300 at age 17 with $2,500 contributions and $500 annual CESG payments. Patricia can balance out the accounts herself so that each child has $45,000 for university. The kids can get summer jobs if needed.

Patricia’s condo has an $810,000 estimated price. It carries a $645,000 mortgage at 2.74 per cent, which costs her $2,725 a month. The mortgage has 28 years to run. The home has a rental suite that provides $9,000 annual income, effectively a 28 per cent discount on her mortgage payments. Her home equity is rising, so keeping it is reasonable, Moran says.

Patricia has a loan for $11,675 for home improvements, with an interest rate of 11 per cent. She has not made full payments and the balance has been growing — it needs to be paid immediately. She can sell her rental property.

TAXES, POOR INVESTMENTS BLEED INCOME

Patricia’s $650,000 rental property generates $32,400 a year before expenses. After $ 4,596 annual property taxes, $ 1,800 annual insurance, $4,800 annual maintenance and annual mortgage interest of $11,167 (not counting contributions to equity) all that’s left is $10,037. That’s a 5.7 per cent return on her equity in the property, $174,800. It’s low for so much leverage, Moran says. Her rental income is fully taxable at an average rate of 38 per cent, so she keeps just $6,200 a year. If her current 2.35 per cent mortgage rate were to rise to 4.46 per cent, her profit would be gone. She could sell it for what she paid, plus many improvements, and thus no capital gains tax.

If Patricia sells the rental property at the current price and pays off the approximately $475,000 mortgage, she could net $150,000 after selling costs. She could elimi- nate other loans — the home reno, the boat, the car loan and the line of credit, which will be down to about $60,000 all-in in a few months — and have about $90,000 to immediately put into her RRSP, where she has $180,000 of room. RRSP contributions would save her 43.7 per cent of what is contributed, for that is her marginal tax rate.

Sale of the rental property would eliminate the mortgage cost of $1,900 a month and other costs for insurance and property taxes. She would have savings of $500 a month, currently going to her RRSP, and $750 rent from her suite in her home, for a total of $3,683 a month or $44,200 a year. With those savings, she could fill her RRSP space in two more years. Going forward, she can aim to fill the present RRSP limit for 2015, $24,930.

PLANNING RETIREMENT

If Patricia sells her rental property, puts $90,000 into her RRSP and adds another $60,000 in the next two years, she would have $152,840 of present RRSP balances, plus $150,000 of new contributions, for a balance of $302,840, plus a refund of $65,550 — for a total of $361,550. By the spring of 2016, when her refund arrives, she will have approximately $25,000 in fresh RRSP contribution room. If she uses it, she will have total RRSP assets of $368,390. That would generate a further $10,925 refund to go to the RRSP, plus growth, say $400,000 total. If she then maximizes RRSP contributions each year to age 65, and if her account grows at three per cent after inflation, she will have a balance of $883,500 at 65. That sum would support payments of $49,260, which would exhaust all RRSP capital by age 90.

Patricia’s next goal should be to build a tax-free savings account. She hasn’t one now. After her RRSP is topped up, she can put in $41,000, the current limit, with just the money she’ll no longer be spending on the rental property — $2,783 a month or $33,400 a year with a $7,600 top up from next year’s income. If she then puts in $10,000 a year to age 65, she would have $188,700. That would support annuitized annual payouts of $10,500, consuming all capital in 25 years to her age 90.

Her expenses and allocations, now $15,750 a month, could be slashed to $5,573 in retirement by cutting $1,000 a month of child support, disposal of one car to save $1,200 a year in operating costs and insurance, all costs for the rental building she will have sold, cutting $800 a month from her food budget, eliminating her commuting fees, cutting her travel budget in half and elimination of all loan payments other than her home mortgage, and all savings.

If Patricia works to 65, then for the next 25 years her annual income would consist of $49,260 from the RRSP, $10,500 from the TFSA, $12,780 from the Canada Pension Plan, and, at 67, OAS benefits of $6,778. All sums are in 2015 dollars. She would still have rental income of $9,000 a year. That adds up to $88,318 a year. After 20 per cent average income tax based on age and pension credits, she would have $5,900 a month to spend. Her costs would be covered with just $327 each month to spare for unexpected expenses. Retiring before age 65 would mean her savings from work and compounding investments would not have produced sufficient capital to generate income for retirement. She could work part time from 65 to 67 when OAS starts, Moran adds.

Patricia’s RRSP and TFSA would be exhausted at 90, but she would have her home to sell if she needs cash.