Prognosis not good for couple late in starting retirement planning
In Ontario, a couple we’ll call Larry and Sue, both 61, are headed into retirement without a plan. They have two rental properties, one of which is profitable and the other which breaks even, no RRSPs, no TFSA and $68,000 in cash. Their liabilities add up to nearly $350,000. Both health care professionals, they have small defined-benefit pensions. The clock is ticking on a bad situation.
“Can we afford to retire and if we do it, how much disposable income would we have?” Larry asks. It’s a question they should have asked a decade or more ago, but there is still time to act.
The couple’s problems are complex. They live for free with a relative and have no home of their own. There is credit card debt of $25,000 with average 19 per cent annual interest charges. Their largest property investment is a Toronto rental with a $500,000 estimated market price that generates a 1.88 per cent return (rental income less property taxes, condo fees and other costs) on their equity which is not much for the risk and bother. The other rental, with a $175,000 estimated market price, generates a healthy 4.13 per cent return on equity. It is in Western Canada. Their net worth is about $395,000. For folks at their stage of life it is not a lot.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Larry and Sue. The irony of their case is clear, he says. “These folks are in the business of counselling people with personal problems but they have neglected their own financial problems.”
MANAGING DEBT
Larry and Sue must improve their retirement cash flow, and the first step is to tackle their debt. They should draw down their $68,000 in cash to pay off $25,000 in credit card debt. The cash earns barely one per cent in the bank. That leaves $43,000 for investment in RRSPs or TFSAs. The couple expects a $300,000 inheritance someday, but the vagueness of the timing excludes planning for that money for any purpose now.
They should also rationalize their real estate holdings. The two properties have conventional uninsured mortgages, both with 30-year amortizations. Property 1 is in Toronto. It has a $158,502 mortgage. Larry and Sue pay mortgage interest of 3.59 per cent for Property 1.
They could sell Property 1 and reap proceeds of about $350,000 (excluding capital gains tax). Or they could keep the unit, and move into it if they wish. That way, they would have a home of their own. They have never lived in the property, so if they choose to do so, they would have to file a change-of-use election with the Canada Revenue Agency, declaring that the property will be for personal use henceforth. Payment of capital gains tax could be deferred under CRA rules until the property is sold.
Property 2, in Alberta, has an annual management fee of $1,344, about 10 per cent of their gross annual rent from the unit. It has a $165,787 mortgage with a 3.75 per cent interest rate.
Larry and Sue expect to get perhaps $300,000 from a bequest. For now, the best bet is to wait for the market to turn up and then sell. Within a few years, if the inheritance materializes, the couple could pay off the mortgage on the second, more profitable unit and have perhaps $135,000 left. That money could go to TFSAs. Neither partner has one. Larry’s monthly gross income, $3,734, is too low for an RRSP to make sense. Sue has a $5,000 monthly gross income, so she could set up an RRSP. If timing is right, she can put $13,000 into her RRSP each year, using up space to bring her down to the lowest tax bracket.
RETIREMENT PLANS
In retirement, assuming that both Larry and Sue work to 65, Larry will receive a defined-benefit pension of $900 per month for life. Sue will get $1,850 per month for life. Combined at age 65, Larry and Sue will have $1,873 each month from the Canada Pension Plan and a combined total of $1,215 per month from Old Age Security.
If Sue puts $13,000 into her RRSP, then with similar contributions for four more years to age 65, the account, growing at three per cent per year after inflation, would have a $69,000 balance which could support payouts of $3,000 per year for 25 years, at which time all income and capital would have been paid out.
Once both partners are 65 and retired, their monthly income will consist of two work pensions that total $2,750 per month, CPP benefits of $1,873 per month, combined OAS benefits of $1,215 per month and $250 per month from Sue’s RRSP. That adds up to $6,088 per month or $73,056 per year with a potential increase if the couple has set up TFSAs. We are not including rental income for we assume that they will move into Property 1 and, when the market improves, sell Property 2, clear the mortgage and have nothing left over. With pension incomes split and age credits applied, taxes would average 12 per cent, leaving $5,360 monthly for spending. It would be a comfortable retirement.
They would have no credit card charges. They would be rid of one mortgage payment of about $500 per month, $400 per month in condo fees, and have reduced costs without commuting to former jobs. If monthly cost of living dropped to $4,000 to $4,500, they would have sufficient after-tax income and a margin for travel.
RISKS TO THE PLAN
When one partner dies, there will be a loss of OAS, most or all of one CPP benefit, and the tax benefit of splitting pension income. That would cut cash flow by $1,507 if Larry passes away or $2,107 if Sue dies, turning an adequate retirement income into one that is barely sufficient. The best provision for this event is to build up financial assets through better budgeting and dedicated saving in RRSPs and TFSAs, Moran notes. Brushing up on their investing knowledge in order to understand how to distil good deals from bad ones wouldn’t hurt either.