She’s worked hard and saved hard, but is that enough?
In Ontario, a woman we’ll call Kate, 58, is thriving in her job as a packaging manager for a large company. She brings home $10,800 a month and saves aggressively. She has no debts, but she worries that when she is in her 80s, she will not have the resources she needs for independent living. She has no company pension plan, but her savings are substantial.
Kate’s question is whether her savings will be sufficient for her to renovate her house for a time when she can no longer handle stairs, perhaps move into a care facility, or, in the alternative, build a nanny suite and move into that one day, renting out her house for additional income. She sees total retirement as her goal at age 60.
Has she saved enough to make it work for the following 30 years?
“When I retire, I want to travel for two weeks per year, perhaps go to music festivals, and to stay in my house as long as possible,” Kate says. “Timing complete retirement is going to depend on the money I need and the alternative of moving into a care facility at, say, $5,000 a month?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Kate on her web of choices.
“This is the story of a woman who worked hard and saved diligently,” Moran explains. “There are no rich relatives, lavish inheritances or lucky investments. Her issue is clear — how can a person with no spouse, no children and no other longterm supports plan a retirement maintaining independence as long as possible?”
PRESENT ASSETS
The numbers in this case provide some comfort. Kate has assets of about $1.6 million and no liabilities. $860,000 of the total is in her RRSP, which provides very important tax postponement, and her TFSA, quite underfunded at $6,000 total. Until recently, she used savings to pay down and eliminate her mortgage.
Kate’s house, with a $700,000 estimated value, is 43 per cent of total assets, fairly reasonable these days. The question now is how to use her $38,333 of cash. Some is earmarked for her RRSP, some for renovations and landscaping, some for adding to her tax-free savings account. But those choices are just for the moment. Kate saves $6,689 per month in cash, RRSP and TFSA accounts, which is a stunning $80,268 per year. That’s after tax. Her problem is planning more than budgeting, Moran notes.
If Kate builds a nanny suite for $70,000 with the expectation of generating $12,000 a year in rent — that’s 17 per cent of the outlay, the cost would be paid back in six years. Utilities and maintenance could cut the rate of return to something like nine per cent or $6,300 a year — still a solid gain with relatively little risk, and rental income should keep up with the rising cost of living.
INCOME MANAGEMENT
Rather than pay the nanny-suite construction costs out of pocket, Kate should borrow all the money needed to build the suite and amortize the loan for as long as possible, Moran recommends. That way, she will have a formal cost to use to reduce income. The money she saves up front by using her lender’s money to pay her construction costs can go to her underfunded TFSA. Given her high rate of free savings after present contributions to her TFSA and RRSP, she has $5,526 free cash savings each month. She can easily allocate $46,000 to bring the account to its present limit of $52,000 and then add $11,000 or $5,500 per year into the TFSA in the next 18 months. The account would then be at its 2018 limit of $63,000.
Kate’s actual outlays without unallocated savings are $5,526 per month including $1,415 savings to her RRSP and TFSA. She estimates needing $50,000 to $55,000 a year after tax in retirement. $62,000 a year of fully taxable income would leave her with $50,000 after tax at an approximate tax rate of 20 per cent. To get $55,000, she would need to generate $69,000 a year. Her actual tax rate will be reduced by the pension credit at age 65.
RETIREMENT PLANNING
Most of Kate’s retirement income will be based on her savings in her RRSP and TFSA and her projected apartment rental income from the suite to be built.
We’ll assume her $860,000 RRSP grows at five per cent less three per cent for inflation for another 1.5 years to her projected retirement. It will then have $886,000. Converted to an annuity growing at the same very conservative two per cent rate after inflation for 30 years to her age 90, it would generate $39,560 per year.
Her TFSA has a present balance of $6,000. If Kate boosts the sum to $63,000 by the end of 2018 and then ceases contributions, the account, generating two per cent a year in 2017 dollars for the following 30 years would pay $2,800 per year with no tax exposure.
Kate can expect at least 95 per cent of full Canada Pension Plan benefits at 65, currently $13,370 per year — that’s $12,700 per year, and full Old Age Security benefits, currently $7,004 per year, at 65.
At 60, Kate’s gross income would then be her RRSP income, $39,560 per year, untaxed TFSA income of $2,800 per year, and net rental income from the nanny suite of $6,300 per year. Assuming 20 per cent tax on all income other than TFSA payments, it would leave her with about $39,500. It is short of her $50,000 after-tax lower-end target. She could cover the gap for the five years to 65 by raising RRSP withdrawals in early retirement before CPP and OAS begin at 65.
At 65, Kate would have RRSP income of $39,560 per year, TFSA income of $2,800 per year, net rental income from the nanny suite of $6,300 per year, CPP income of $12,700 per year, and OAS income of $7,004 per year, all in 2017 dollars. That adds up to $65,564 with the exclusion of TFSA cash flow. The 20 per cent assumed tax rate would leave her with about $52,450. Add in the untaxed TFSA income and she would have net income of $55,250, above her upper range target of $55,000 after tax.