Couple’s aversion to financial assets could be fatal to retirement hopes
In Saskatchewan, a couple we’ll call Sam, who is 35, and Mary, who is 30, have two preschool kids and $495,000 of debts. That’s 5.5 times their annual take-home income. They want to finance the post-secondary education of their children ages 5 and 3, then retire at 60 or 65. Their issue — can they achieve these targets without any meaningful investment of savings?
Sam works as a consultant for a machine tool company. Mary has a home-based knitting business. Their take-home income, including $500 per month from the Canada Child Benefit, is $7,500 per month. Neither has a job pension.
“Should we pay down the mortgage or invest our money in something?” Mary asks. The “something” is critical, for Sam and Mary refuse to invest in financial assets or rental housing. However, they want to retire when Sam is 65 with an income of $6,500 a month before tax. “How much would we have to save each month to have $1,000,000 in our RRSPs by age 65?” Mary asks.
Family Finance asked Elliott Einarson, a Winnipeg-based financial planner with fee only advisory firm Exponent Investment Management, to work with Sam and Mary. The core of the problem of building up family assets for education and retirement is the couple’s attitude toward investments. “I don’t want to put my money into anything like a business I cannot watch or a rental property used by a tenant I cannot control,” Mary explains.
They have substantial debts and future obligations. In addition to their $360,000 mortgage, they owe $135,000 on a home equity line of credit. They own a plot of unimproved rural land for which they paid $90,000. They think they could rent it for farming at $6,750 net after interest cost — not deductible until it produces income. Farm land is illiquid and is not eligible for investment in RESPs or RRSPs. They think they could sell it for $125,000. The profit based on cost is 8 per cent or 5 per cent based on estimated present value. Sale would entail tax on half the gain. The after-tax gain could be used to fill up RESP space. The kids will go to university before the parents retire, freeing up cash flow for other savings, Einarson explains.
EDUCATION COSTS
Sam and Mary want to build up their Registered Education Savings Plan, which currently holds $6,000. If they had contributed the maximum of $2,500 per child per year, for a total of $20,000, they would have also received the maximum $500 Canada Education Savings Grant for each child each year, another $4,000 in total. However, they are $18,000 behind what they might have accumulated, and there is no indication they plan to make a significant catch-up contribution.
If RESP contributions continue at $216 per month, which is slightly more than the maximum rate for one child, then, conceptually splitting the $6,000 present balance into two accounts each with $3,000, and contributions into two $108 monthly additions, the younger child with 14 years to go to the end of the age 17 qualification period for the CESG would have about $21,000 for post-secondary tuition, enough for a local institution and living at home. The older child with 12 years to go to the end of the CESG qualification period would have $18,500 for post-secondary education. Averaged, each child would have about $19,800 for post-secondary education. That would cover tuition and books at a local institution for several years.
DEBT AND RETIREMENT
Their 2.2 per cent mortgage costs them about $1,610 per month to service. It has 24 years to run. Their 4.5 per cent $135,000 line of credit costs them $720 per month — $500 for interest and $220 for reduction of outstanding balance. In all, they pay $2,330 a month on the two debts. Interest on the loans is not tax deductible for neither loan is used to generate income, Einarson notes.
Sam and Mary want to retire in 25 years when Sam is 60. Their RRSPs have a total combined balance of $500. They have no Tax-Free Savings Accounts.
Sam and Mary reject the idea of conventional investment in assets which produce interest, dividends or capital gains. This attitude is fundamental to their thinking. It has serious implications for their future.
If they save $400 per week or $20,800 per year in their RRSPs, which is feasible with spending cuts, but earn nothing on the money, then in 25 years the sum of $500 present RRSP savings and the annual contributions as indicated would be $520,500. If that is paid out over the 35 year period from her age 60 to her age 95, it would yield $1,238 per month. Saving without gains would leave them far from their $6,500 monthly goal.
In order to attain a $6,500 monthly pre-tax retirement income, Sam would have to work 30 years to 65 and invest in productive assets. The effect on their future would be dramatic.
If they continue to save $400 per week and the accounts were to grow at an average rate of 3 per cent per year after inflation with an aggressive strategy, they would have about $1,000,000 in 2017 dollars on the eve of Sam’s retirement at 65.
Were RRSP payouts based on a 3 per cent investment return after inflation spent over the 35-year period from Mary’s age 60 to her age 95, they could obtain $46,000 per year, or about $3,800 per month. Add Sam’s assumed Canada Pension Plan benefit at 65, $13,370 at present rates, and Mary’s estimated CPP at 60, $2,852, and Sam’s Old Age Security at 65, $7,004 per year at present rates, and the couple would have a starting pretax retirement income of $69,226 per year or $5,768 per month before tax. That would be $730 a month short of their age 65 pre-tax retirement goal of $6,500 per month.
Allowing for investment growth, they would need to save an additional $72 per week to reach their goal. Foregoing interest altogether would leave them without much of a retirement at all.