‘They just work and save and invest’
NOW ALL THIS COUPLE NEEDS IS A LITTLE DIRECTION TO GET THE RETIREMENT THEY WANT
A couple we’ll call Louis, 55, and Mary, 50 live in B.C. with their two children, who are in their early 20s. They bring home $8,900 a month from two jobs, his in the building trades, hers in health services. Their goal: retire in five years when he is 60, buy a $300,000 investment property, then travel to see the world.
“We’d like to buy a motor home for travel in North America, then move to Europe for six months,” Mary explains. “Our gift to our children is to pay for their education so they do not start their adult lives in debt.”
The problem is whether their approximately $490,000 of financial assets in RRSPs and TFSAs and two defined benefit pensions that will generate $6,657 a month when their retirements start will support their plans.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Louis and Mary to determine if their retirement budget will support their plans if, as they hope, they quit their jobs in five years when Louis is 60. “This couple is a classic first-generation wealth building family. They just work and save and invest. With a bit of direction, they can achieve their goals.”
RETIREMENT INCOME STRUCTURE
Most of the couple’s retirement income will come from their defined benefit work pensions. The irony of their finances is that their gross monthly income, $15,444, gets chopped down to $8,900 per month by large payroll deductions, which help to finance their definedbenefit pensions.
Those pensions will, once both are 65, provide them with $6,657 a month before taxes.
What will make their retirement plans feasible is that their present expenses have costs that can be stripped out in retirement — savings of $916 per month for their TFSAs and $1,475 a month paid to their children for their post-secondary educational expenses. Without those expenses, their cost of living drops to $6,509 per month from $8,900.
There are two problems, however. First, the pension income will not, after tax, be enough on its own to cover those costs. Second, and more importantly, if they retire when Louis is 60, they will have to take big cuts in pension income and CPP, Moran notes. His work pension, $3,642
per month at 65, would be cut back by $1,300 per month if he starts drawing it at 60.
He would also start CPP with a 7.2 per cent cut for each year before 65, total 36 per cent or a $400/month reduction
That’s $1,700 per month in lost pension and CPP for quitting at 60, Moran estimates.
On top of that, Mary cannot receive her pension of $3,015 until age 58 — that means that if they stop working at the same time, his reduced pension of about $2,300 and reduced CPP of about $700 per month would be their only source of income for the first three years.
Bridging the five years from retirement at 60 to start of full pensions at 65 is clearly the problem.
Both Louis and Mary have relied on work pensions for most of their retirement savings because large pension deductions from their paycheques have reduced their funds for private investment in RRSPs or anything else, for that matter. Moreover, the Pension Adjustment, which reduces the 18 per cent limit of gross income maximum deduction by the amount paid into their job pensions, cuts their potential RRSP savings. They have respectable investments in a family of fairly low-fee mutual funds for their RRSPs, total $317,274, and their TFSAs, total $103,532.
They have $70,000 of cash, but much of that is reserved for house repairs and other contingencies. Assuming their invested capital of $420,806 generates 3 per cent per year after inflation, it would produce $12,627 per year in 2018 dollars. However, if they start retirement when Louis is 60, that income alone — about $1,000 per month — would not be enough to bridge the gap.
Taking a different tack, Louis could defer taking his pension until 65, when he could receive the full amount, and instead try to draw down his $123,690 personal RRSP. (At 65, they could then start drawing on nearly $300,000 held in their spousal RRSPs and TFSAs.)
Yet the present value of his personal RRSP drawn down over five years would provide only $24,738 a year.
Drawing down their TFSAs could supplement that. The current balance of $103,532 with contributions of $10,992 a year plus 3 per cent after-inflation growth would end up at $180,130, and yield withdrawals of $36,100 a year. That would boost gross income to $60,838 or $4,460 a month after 12 per cent average tax, but it would still not be enough, Moran says.
To make such a plan work, Louis would have to boost his present $123,690 RRSP balance by using up $89,000 of contribution room over the next five years. That space plus about $6,000 of new room added each year, a total of $119,000, would give him about $243,000 of total personal RRSP savings. Add in growth of about $40,000 and the funds would sustain the five year drawdown needed, Moran estimates.
BOOSTING RETIREMENT INCOME
Once Louis is 65, their pre-tax income will rise dramatically. Their job pensions will generate up to $79,884 per year. Mary will have a $12,120 bridge to 65. If Louis does quit at 60 but does not draw CPP until 65, he would have about 94 per cent of the full CPP benefit. That would work out to $12,570 per year. His Old Age Security would add $7,026 to income. They could have $111,600 before tax. With splits of eligible income after 20 per cent average tax, their income would be more than $7,400 per month.
When Mary is 65, she would lose her $12,120 bridge but gain $9,000 CPP and $7,026 OAS.
Mary’s present RRSP assets total $193,584. If this capital grows at 3 per cent after inflation with no further contributions, then in 21 years at her age 71, on the eve of conversion to the Registered Retirement Income Fund, it would have a value of $360,123 in 2018 dollars. That capital could generate $21,265 a year in before-tax income for the 24 years to her age 95. That would supplement income from their job pensions. Their annual income going forward would be $136,771 before tax or $9,120 a month after 20 per cent average tax. If they rent a motorhome as needed, their income would meet their needs, Moran concludes.