National Post (National Edition)
Can careful saving of modest income guarantee retirement goal?
Adivorced Ontario woman we’ll call Nancy, 60, is approaching retirement in five years with trepidation. Her company, a small business providing subsidized housing, does not offer a defined benefit pension. She will be on her own.
“I want a retirement income of $35,000 per year after taxes,” Nancy said. “How long will I have to work to reach that goal? Should I continue contributing to my RRSP or openaTFSA?”
Family Finance asked Derek Moran, a fee-only financial planner who heads Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Nancy. “On the good side of this case is that Nancy has no debts. However, her resources for making large changes to her financial reserves are quite limited. Still, there is a good deal we can do to increase potential retirement income,” he said.
Nancy raised four children, now adults, with little financial help from her former husband. She continues to help the children with modest gifts. She gets tax relief via annual refunds of about $1,000, but her cash flow is tight and fully allocated.
One daughter and her husband live with her, but have no money to contribute to her expenses.
RETIREMENT INCOME
Assuming that Nancy works to age 65, she will have modest financial security, based on current savings and benefits from the Canada Pension Plan and Old Age Security, Moran said.
Her current RRSP balance is about $200,000, and is growing at $8,360 per year with her own contributions of $5,496 and contributions from her employer of $2,864. That should grow to $276,200 in 2018 dollars in five years, assuming a three per cent return after inflation.
RRSP contributions in her low income bracket are not tax efficient, but since the employer matches half of her contributions, it’s worth adding to the plan.
If her RRSP is fully paid out over the following 25 years to age 90, it would support an indexed taxable income of $15,864 per year. Canada Pension Plan benefits will add $11,840 and Old Age Security will contribute $7,075 for total annual income of $34,779.
Assuming an average tax rate of 12 per cent, Nancy will have $30,600 per year to spend, below her $35,000 target.
There is a good deal Nancy can do to boost her income, Moran said. The least risky move would be to downsize her house, with a current estimated price of $600,000, to something in the $400,000 range. The $175,000 left after a few repairs and estimated selling expenses could support a $5,250 annual payout with a three per cent after inflation return and no capital expenditure indefinitely, leaving the capital intact for late life needs or gifts to her children.
WORKING LONGER
Another option is for Nancy to work five more years, retiring at age 70 and deferring the start of her Canada Pension Plan benefits. Even without further contributions, should she shift to contract work for her company, payouts would rise by 42 per cent over the age 65 benefit, to $16,800 per year.
Her annual Old Age Security benefit, with the start date delayed to age 70, would rise to $9,622. Her $200,000 RRSP savings, with ten more years of annual $8,360 contributions, would rise to $367,500 and support 20 years of payouts of $24,700 before all capital and income are exhausted.
Those moves would push her total income up to $51,122 before tax, or about $43,450 per year after 15 per cent average tax. Income would be $5,250 more with the investment return from house downsizing: $56,370 before tax and $47,920 per year after 15 per cent average income tax.
While working five more years would boost retirement savings and reduce the time for drawdowns of capital, it is not absolutely necessary if she downsizes her house.
INVESTMENTS
Nancy could also move to raise the return on her RRSP. Currently, it is invested with a respected manager and carries a relatively moderate management expense ratio of just over one per cent per year.
Nancy has $20,000 cash in a savings account as an emergency fund. The account pays virtually no interest and there is thus no tax on her income from it.
She could open a Tax-Free Savings Account. If she were to put half of her cash into the account, she could invest it in a low-fee mutual fund or an income generating exchange traded fund. The money would be liquid and its income is tax-advantaged at withdrawal.
Finally, as a matter of tying up loose ends, Nancy should reconcile her spending with her income. At present, her take-home income is about $3,256 per month. However, her daughter and son-in-law may eventually move out and that would lower fuel bills for her car. If Nancy cuts $200 out of monthly driving costs, as she will in the normal course of retirement, eliminates $458 RRSP contributions, and $500 non-registered savings, her monthly living cost would drop to $2,098, for a total of $25,176 per year. Those adjustments would make her expenses supportable on $30,600 per year after tax, which she can manage without downsizing her house. “If Nancy chooses to work longer and to invest her substantial cash, she will be even better off,” Moran said. “Her frugality ensures a secure retirement.”