Paying off debt crucial in pair’s planning for retirement
COUPLE’S NET WORTH $200K
Acouple we’ll call Sally, 54, and Mike, 52, live in Alberta. They both work as personnel specialists, but have only been in their current roles for six and eight years, respectively. Sally and Mike have two children, aged 18 and 20, but their financial assets are modest: A house worth $400,000 on a 40-acre plot, and additional assets worth $148,000, including 12 acres of raw land, a car, a truck, four horses and a trailer. They also have $341,524 in debt, leaving their net worth at just over $200,000 — not a lot for folks expecting to retire in 10 to 15 years.
“We have put everything into our house and land,” Mike explains. “We have no RRSPS, no TFSAS, and no savings apart from $10,000 in chequing. We will have benefits from our employer, but with just a few years on the job, it won’t be a whole lot. Our dilemma is how we can retire with a monthly income of $5,500 after tax?”
Family Finance asked Eliott Einarson, a financial planner with Exponent Investment Management in Ottawa, to work with the couple. “They want what most couples want,” Einarson says. “A decent income in retirement, the ability to help their younger child with university costs in spite of the lack of any education savings, and the hope they can leave something for the children. All this revolves around the question of when they can afford to retire — perhaps 60 as they would like, but with no retirement savings of any sort, 65 is more realistic.”
DEBT MANAGEMENT
Income and expenditure numbers show the problem. Out of a combined monthly take-home income of $8,825, the couple spends about $7,400, leaving just $1,425 for saving.
Paying down their debts needs to be a priority.
They have recently received a one-time retroactive pay adjustment worth $16,450 after tax. Using that money to pay down a $15,400 trailer loan which carries a 7.98 per cent interest rate that costs them $208 per month to service would be a good start.
The $208 monthly instalment they have been paying for the trailer will be liberated, bringing their monthly surplus to $1,633. If applied to their outstanding credit card debt, $10,630 on which they already pay $130 per month, boosting payments to $1,763 per month, it will be gone in six months. If that money is then directed to the home equity line of credit (HELOC) with a $50,000 balance and a $150 monthly cost, total $1,913, the HELOC will be history in a little more than two years. Thus in about three years, they will have only one debt, their mortgage.
The current mortgage loan term has about 20 years to go. If Sally and Mike raise their present $1,575 monthly payments to $3,575 with liberated cash and their monthly surplus, the outstanding balance of $265,494 will be gone in seven more years at their respective ages of 64 and 62. Their job pensions severely limit what they can put into RRSPS, but each will have abundant TFSA space. If there is money left after perhaps helping pay off student loans or buying new vehicles, for theirs will be quite old by then, it can go into tax-free savings.
TIMING RETIREMENT
Timing their retirement will be critical. Sally and Mike will be 65 years old in 11 and 13 years, respectively. Sally’s work pension will provide $18,096 annual gross income at her age 65. Mike can expect $24,168 gross pension income at age 65. At 65, they can add CPP of $10,698 for Sally and $11,508 for Mike and two Old Age Security benefits of $7,160 each for total income of $78,790. If this income is evenly divided via pension income splitting, they would have $39,395 each of tax liability. After 15 per cent average income tax, they would have $66,700 income per year or $5,580 per month to spend, a little over their $5,500 target. They would have no debts to service. Their house would be paid, they would have their recreational property, and their children would have their own lives, allowing a reduction of the $1,200 per month they now spend on food and perhaps some of the $802 a month they now spend on their car for fuel and repairs.
Retirement before the time each is 65 would be problematic. They would not have Old Age Security benefits. If they take CPP early when each is 60, the cut would be 36 per cent for each or $3,850 for Sally and $4,142 for Mike. That would take a combined total of $666 per month out of their retirement budget before tax. They would also have five years to go to the time they could take Old Age Security. That would take another $596 each per month before tax each out of their cash flow. Their work pensions would have a lower accumulated value even with a bridge to 65. We can estimate a further $500 per month each for reduced payments. The total cost for retiring at 60 would thus be about $2,858 per month, about half the income they could expect at age 65. Retirement before at least one and best both reach 65 is not feasible, Einarson concludes.
HELPING THE KIDS
Sally and Mike say that they want to help their kids with a testamentary gift after they are gone and to help their younger child with university expenses. They have no RESP. However, even with the debt-reduction plan proposed, it will be too late to provide more than a couple of thousand dollars per year for tuition and books. They can provide room and board if he lives at home. A summer job and student loans are essential. If the parents want to do the hoped for $10,000 of home improvements, there would be nothing left for tuition. Best bet — postpone the home improvements until their child has a first degree, then help with student loan payments.
“They can retire securely at 65, but without significant financial assets, they don’t have a lot of choices,” Einarson says.