PENSION-RICH, CASH POOR CIVIL SERVANT CAN CUT DEBT TO SECURE FUTURE
A woman we’ll call Sally, 55, has a good life with a $70,200 annual take-home salary from work in the Saskatchewan civil service plus $10,800 annual gross rental income ($ 7,200 after tax) from a basement suite. A daughter in her 20s lives independently. Sally spends modestly while paying down her $169,295 mortgage, but she is unsure of how to balance remaining years of work and the retirement income she seeks.
The foundation of her income will be a government pension that will be between $ 2,777 a month ($ 33,324 a year including a $ 6,132 bridge) if she quits her job at 60 and $4,244 per month ($ 50,928 per year with no bridge) if she hangs in to age 65. A defined contribution pension, effectively an RRSP, from a former job adds to her financial security and as well, to the complexity of her retirement finances. She needs to get the math right, for she has no other means of support.
“Can I retire comfortably in five years or should I wait ’ til 2026?” she asks. Sally has other concerns. She wants to give her daughter help buying a home, but she has just $9,000 in cash in the bank. Her problem is allocation and it is a worry.
Sally could take money from her $45,000 TFSA. That would deplete her largest readily accessible account. Another $381,131 is tied up in a defined contribution pension plan with a former employer. Withdrawals from the plan would be taxable at about 48 per cent. To obtain $100,000 on that basis after tax, she would have to take out about $192,000. It’s a costly way to get spending money.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Sally. “Her only financial liability is her mortgage. Yet she has saved so diligently in her TFSA, RRSPs and employer pension plans that she has little actual cash. Her problems are liberating some money to pay down her mortgage before retirement and choosing when to retire, for timing will substantially determine her future income.”
SAVING, SPENDING
Sally has little direct control over her largest financial asset, an employer’s defined contribution pension plan from a former job, Moran notes. It is separate from her present defined benefit plan which is not her money nor under her control. She can continue to make $400 monthly contributions to her RRSP, which has a present balance of $7,000.
It’s a good idea not to go into retirement with debts. Sally’s $ 169,295 mortgage with a 3 per cent interest rate will be repaid in 9.5 years at the present rate of payment. Her retirement target is five years. The combination of her job pension plus the proceeds of her RRSP can give her adequate retirement income.
Therefore, Moran suggests, she can drain her $45,000 TFSA for a single, one-time payment. It is allowed by her mortgage and will cut the amortization to 3 years and one month. She will save $17,430 of interest, he estimates. She will lose the inter- est deduction for the rented suite — the proportion of the house rented — in her basement, but the interest saving is worth it, Moran notes. Future savings can go to her refillable TFSA if she wishes.
Sally’s retirement income can grow with addition of the present $400 per month to the existing base of $388,131 — the DC plan plus her RRSP. If she achieves a 3 per cent return after inflation the combined total will become $475,500 in five years. If this sum continues to grow at this rate and is paid out in full by her age 90, it will produce $23,550 per year. Management of her company DC plan has been excellent and it is inexpensive. Sally will also be eligible for Canada Pension Plan benefits. To be conservative, we’ll allow 90 per cent of the full maximum benefit, which is $13,370 at 2017 rates. That would be $12,033 per year at 65. She will also be eligible for full Old Age Security at 65. That amount is presently $6,942 per year.
RETIREMENT BUDGETING
If Sally retires at 60, she would have a $ 27,192 annual defined benefit pension plus a bridge to 65 of $6,132 a year. Her RRSP would add $23,550 per year. Rent would bring in $10,800 a year. We’ll assume her TFSA remains depleted or is used for a gift to her daughter to help her buy a house. On this basis, her pre-tax income would be $67,674 per year before tax or $4,600 a month after 18 per cent average income tax. With her mortgage paid off, her monthly expenses would drop to $4,760, which is just about equal to income.
From 65 onward, Sally will have her base government pension of $27,192, $23,550 from her defined contribution and RRSP pension, $ 12,033 from CPP, $ 6,942 from Old Age Security and $ 10,800 a year from rent. The sum would be $80,517 a year. After 23 per cent average tax with pension income and age credits, Sally would have $5,170 a month to spend. The clawback, which begins at about $74,000 income per year, would take about $1,000, Moran estimates. It would be a modest bite, he adds.
The risks to these projections are not so much on the income side, which is mostly guaranteed defined benefit pension flows, CPP and OAS, but on the side of spending.
WORKING UNTIL 65
If she defers retirement to age 65, her income would rise with a base pension of $ 50,928 per year ($ 4,244 per month) before tax, pushing total pre-tax income to $104,253. After 25 per cent average tax, she would have $ 6,500 a month to spend. That would cover her spending with a large margin if, as advised, her present mortgage payments of $1,686 a month have ended. Five more years of RRSP savings would add $24,000 to her RRSPs. Annuitized for 25 years, it would add about $ 1,000 to her monthly income after the clawback and 25 per cent average income tax for permanent income of $7,500 per month to age 90.
If Sally continues to live modestly, then her retirement should be secure. “We’ve used a 30-year limit for her annuitized income, but if that ran out, there would still be her defined benefit pension and OAS and CPP and her house, which she could sell,” Moran concludes. “This retirement plan would be hard to derail.” email andrew. allentuck @ gmail. com for a free Family Finance analysis