A model of prudence, but she still needs to cut costs
In Vancouver, a woman we’ll call Martha, 57, is planning her retirement. A technical support worker in e-commerce, she brings home $3,950 a month. She manages her financial affairs herself but worries that her savings and government benefits won’t be enough to see her through retirement.
Everything about her life speaks of competence from her career path to her portfolio of dividend-generating stocks in her RRSP and TFSA with a combined value of $387,000 plus $40,000 cash. She owns her $650,000 condo outright with no mortgage, has no loans, and lives modestly. Her largest allocations in her budget are to RRSP and TFSA savings. She drives a car she thinks is worth $5,000, walks to work, takes a holiday every other year and spends modestly. She is the model of prudence.
With no dependants, Martha’s retirement decisions are hers alone to make. “I have no employer pension plan, so I will have to retire and live on my own resources,” she explains. “I hope to retire at 62, but should I sell the condo and move to a less expensive place in the B.C. Interior? Can I afford $15,000 of condo repairs? Moreover, to generate a $35,000 pre-tax retirement income, when should I start my CPP and begin drawing down my TFSA and RRSP? Start them early and CPP later or vice versa?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Martha.
PRESENT FINANCES
“The core issue in this retirement situation is the high value of Martha’s condo, $650,000 or even more in the effervescent Vancouver market, as a fraction of her $1,082,000 net worth,” Moran says. “The condo is 60 per cent of her wealth. It is hard to avoid that kind of concentration in Vancouver. The temptation is to cash in, but I don’t think she will have to do that.”
To meet her $35,000 annual pre-tax income goal, Martha should continue present contributions of $900 per month to her RRSP, $450 per month to her TFSA and $500 per month to non-registered saving, Moran suggests.
RETIREMENT CASH FLOW
The RRSP with these contributions would grow from the present balance of $322,000 to $430,000 in five years at her age 62 in 2017 dollars, assuming a 3 per cent return after inflation. That sum, if spent over the 28 years to her age 90, could support an income of $22,920 per year.
Her TFSA would grow from a present balance of $65,000 with annual contributions of $5,500 for five years with 3 per cent assumed return after inflation to $104,553. That sum, if paid out over the next 28 years to her age 90, would generate a cash flow of $5,572 per year.
Non-registered savings of $40,000 less $15,000, $25,000 net, for repairs but growing at $6,000 a year with a 3 per cent rate of re- turn for five years to age 62 would become $61,800. If that sum continued to earn 3 per cent and is paid out for the next 28 years to age 90, it would generate about $3,300 per year in 2017 dollars.
The sum of these payments, $31,792, is $3,200 short of her $35,000 pre-tax annual spending goal. The shortfall would disappear when she starts to receive Canada Pension Plan and Old Age Security benefits.
Martha can avoid dipping into any of her savings beyond taking the scheduled payments by a few economies. The easiest is to apply for the B.C. Seniors Property Tax abatement, a plan that allows persons over 55 to borrow local property tax payments from the province at a recent cost of 7/10ths of one per cent per year with no compounding. The province puts a lien on the home, which has to be the principal residence, repayable when the home is sold. Martha would save $90 per month or $1,080 a year at a cost of $7.56. She could also cut dining out and entertainment, $270 total present, by $100 a month, saving a further $1,200 a year. And if she reduces travel, currently $3,000 a year, by $900, she would eliminate the small deficiency. The lifestyle cuts would be for just three years.
Or she could preserve her dining out and travel spending by taking CPP at 62 at a cost of 7.2 per cent per year for each year that she takes CPP before 65. She should qualify for the full amount, $13,370 at present, so the discount would leave her with 21.6 per cent less than the maximum, an annual cost of $2,888. If she lives to 90, the total cost of taking CPP early would be $80,864 plus indexation of that amount. It is a huge sum to pay for a three year cash flow fix, Moran says. Better to tap RRSPs or the TFSA early. The cost would be the assumed rate of 3 per cent return after inflation. Moreover, 7.2 per cent growth, which is the other way to look at not taking early benefits, plus indexation, is hard to achieve on a longterm basis in income stocks or with federal government bonds with no risk of default. CPP payouts should not be impaired, Moran says.
Assuming that she starts CPP and OAS at 65, then she would have total income of $22,920 from her RRSP, $5,572 from her TFSA, $3,300 from non-registered savings, $13,370 from CPP and $6,942 from OAS. Her pre-tax total income would then be $52,104 per year. After 15 per cent average tax but no tax on TFSA income, she would have about $45,120 a year or $3,760 per month to spend. That is close to her present income of $3,950 a month, however, with no contributions to her RRSP and almost zero property tax payments, she would save almost $1,000 a month based on her present budget and have much more discretionary income.
A MATTER OF PERSPECTIVE
“This is a significant achievement, for Martha has an average income, no spousal contributions to savings, no spousal splitting of pension income that will eventually come from her RRSP converted to a Registered Retirement Income Fund, and steady but not exceptional investment performance,” Moran concludes.