PERSONAL FINANCE She has the assets of a millionaire, but feels broke — can she retire at age 60?
Cindy, as we’ll call her, is 59. She makes her home in British Columbia. Divorced, her two children are in their 30s and are financially independent. She brings home an average $7,222 per month, but has grown tired of her very competitive business as an independent financial services consultant and of trying to live on fluctuating income.
“I’ve been through a health crisis when, for five years, I couldn’t work. It was hard to make ends meet then. I feel burned out. I want to retire.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Cindy. The challenges are to pay down a $ 272,000 mortgage with a 30-year amortization which costs her $1,091 per month, to get more income from her $580,609 of financial assets, and to make the most of Canada Pension Plan benefits which could start to flow as early as her age 60 next year.
“The irony of this case is that Cindy has enough assets to make her a millionaire yet she feels broke,” Moran explains. “There are issues, of course. Her income has been sporadic. She has no job pension or medical benefits from her work and her financial assets are not efficiently organized from a tax point of view.”
FIRST STEPS
Cindy has a two-bedroom condo and a lot of debt for her age and situation, Moran notes. The condo could sell for $ 680,000. She might move to a one- bedroom condo in her building with a $500,000 price tag and liberate $ 180,000. If she used those funds to pay down her mortgage to $ 92,000, she could then use her $ 72,000 of cash less $ 30,000 for a reserve for emergencies, net $ 42,000 to pay down the mortgage to $ 50,000. If she were to maintain her present mortgage payments of $1,091 per month, it would be paid off in full in just four years. Of course, transaction costs and fees for early mortgage payment, usually three months of payments, would raise her costs slightly, and condo sales fees might reduce proceeds, but the principle and process is clear. She would be rid of the mortgage before age 65.
How much Cindy needs for retirement income needs cl arifi cation. She s aves $ 3,028 each month from her $ 7,222 after- tax income. $ 1,416 goes to her RRSP, $458 to her TFSA, and $1,154 is cash savings. Take those sums out and her basic living cost is $4,194 per month.
Service Canada has advised Cindy that she can expect only $300 per month if she starts Canada Pension Plan benefits at 60. Her benefit at 65 would be $ 469 per month. Her present financial assets, $ 508,609 net of $ 72,000 cash, can generate three per cent per year after inflation or $1,272 per month in 2018 dollars. Put the investment income and CPP at age 60 together and she will have $1,572 per month. With the mortgage paid in four years, her monthly spending could drop to $ 3,103. At 60, she could not support her expenses. At age 65, she could start Old Age Security adding $587 per month for total income monthly of $ 2,159. That’s still short of what is needed.
With the age 65 retirement start date, Cindy’s income would be $ 469 from CPP, $ 587 from OAS, and investment income based on today’s financial assets of $ 1,272 for total income of $ 2,328 per month including $308 estimated monthly TFSA income. It is still not enough.
Cindy needs to do some financial engineering to generate sufficient retirement income. Her income is quite uneven, so we can’t extend present savings rates for another five years. But in 2018, she should be able to make contributions of $ 14,000 to her RRSP. That would bring her total RRSP balance to $102,940. If this capital were to generate three per cent per year after inflation and were paid out to exhaust all income and capital over 30 years from 65 to her age 95, it would generate $ 5,250 a year. The TFSA with a full contribution of $458 in 2018 would rise to $ 78,379. That capital with the same assumptions would generate $4,000 per year.
Cindy’s present $ 346,790 taxable account would, again with the same assumptions, generate $ 17,700 per year. CPP at 65 and OAS would combine for total annual benefits of $12,672. Her total income with these assumptions would rise to $ 35,622, excluding TFSA i ncome. After 12 per cent average tax, she would have $ 31,350 plus the TFSA income, total $ 35,350 a year or $ 2,945 per month to spend. With no mortgage payment, no TFSA, RRSP or cash savi ngs, her budge t would drop to $ 3,103. Trim travel, entertainment and restaurant bills which total $625 a month by a few hundred dollars and she would be in the black with a small margin for unexpected expenses.
FINANCIAL ENGINEERING
Cindy’s investments have a hefty bond allocation, as much as 58 per cent in her RRSP and 23 per cent in her taxable accounts. Investment grade bonds offer income with very low probability of default and reversion to cash at maturity. However, their interest does not rise over time as do many stock dividends and is fully taxable outside TFSAs and RRSPs. Rebalancing of her bond/ stock allocation to raise stock level and cut bonds would lessen the reduction in portfolio value as interest rates rise. It would be worth discussing with her financial adviser, Moran notes.
What emerges from this analysis is that Cindy should stay at work to age 65. Her prospects for paying her monthly bills before 65 are not good. At 65, those prospects become very good. They are improved by mortgage elimination and the start of government benefits. Of course, if Cindy gave up her car, which would be a large loss in mobility, she could get by with earlier retirement. However, in order to maintain her way of life, the conservative path is to stay the course for another six years. Even with deft tax management, she would be at risk of outspending her income before age 65, Moran adds.
“If Cindy retires soon, her way of life will be stressed,” Moran says. “However, five more years of work will provide sufficient income and a cash cushion for unknown costs.”