Fundamental change is a matter of survival

$2M

Awoman we’ll call Jackie, 52, lives in a village in Ontario. An owner of a small business specializing in athletic gear, she has two children ages 18 and 14. Single after an amicable separation, she has a complex monthly gross income that includes $2,575 of business revenue, $3,197 of child support and $13,234 of spousal support. In all, her gross income is about $19,000 a month and, after tax, she takes home about $13,600 each month. In retirement she won’t be able to maintain her comfortable way of life. Payments from her ex will become a flat $12,000 per month when the kids no longer need child support, but end completely at 65, when she will be entirely on her own financially. The bad news is that cuts will have to be deep. The good news is that she has plenty of time to prepare.

Currently, there are hefty expenses for raising two teens. Each month, on top of her monthly $1,436 mortgage payment, she spends $1,570 for food and household supplies, $600 for restaurants, $1,349 for car lease and gas, $1,700 for clothes and grooming, $695 for yard and home care and $450 for the younger child now in her first year of private school. There is also a big charge for cellphones in her $850 expenditure on utilities and internet.

Family Finance put Jackie’s situation to Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. This is not a superficial makeover — it has to be fundamental and it is a matter of survival. “In retirement, Jackie wants a way of life which, with present numbers, she will not be able to maintain,” he explains.

ASSETS

Jackie’s biggest problem in retirement will be income.

The good news is that she has significant assets, which will have to be harnessed to fund her retirement.

Currently, the vast majority of her wealth is tied up in her $1.6 million house and $400,000 cottage. After taking into account the $330,000 mortgage, her equity in the home stands at $1,270,000.

Paying off her 30-year mortgage is a good defensive strategy. She is paying 2.7 per cent now. When the mortgage comes up for renewal in the fall of 2023, rates are likely to be higher. Paying off the mortgage by sale of the house and downsizing makes sense given that her children will have left home by then.

She is also considering selling her cottage and upgrading by buying her sister’s half of their parents’ retreat for $650,000. The extra cash generated by downsizing could put to that use, but would not solve the problem of bolstering her retirement income. She should abandon the idea.

If she captures the $1,270,000 equity in her house and then allocates $770,000 of that to buy a condo instead, she will have an additional $500,000 for investment.

RETIREMENT INCOME

If Jackie were to cut spending and max out her $331,577 RRSP with a $26,230 contribution for 2019 and a similar amount until she retires to fill her available space, the RRSP would rise to $908,876 and, generating three per cent after three per cent growth and three per cent inflation, it would support payouts of $45,019 per year for 30 years to her age 95. The contributions would generate hefty refunds that could go to her TFSA.

Jackie’s TFSA has a balance of $61,237. If she adds $6,000 per year for the next 13 years and it grows at three per cent after inflation, it will become $186,446. Spent over the next 35 years with the same three per cent real return it would support payments of $9,235 per year.

If Jackie does sell her $1.6 million house, pays off her mortgage and buys a $770,000 condo, she would have $500,000 cash left over. If she adds that sum to her $45,445 cash balance in taxable accounts, she would have $545,445. She will need this investment income. If that sum were to grow at three per cent after inflation for 13 years, it would become $801,000. That sum, with the three per cent return assumption after inflation, would support payouts for 30 years of $39,676 per year. Doing this would be a smart move, Moran says.

Adding up Jackie’s income components beginning at age 65, she would have $45,019 from her RRSP, $9,235 from her TFSA, $39,676 from taxable investments, an estimated $8,166 from CPP and $4,910 from OAS after the clawback. That adds up to $107,000 per year. After 24 per cent estimated tax, and no tax on TFSA payouts, she would have about $7,000 to spend each month.

CONTROL SPENDING

Given that that figure is well below her current monthly allocations of $13,600, some pruning to her expenses will be in order.

But some of her biggest expenditures will also no longer be required.

With the mortgage paid down ($1,436), her youngest’s schooling complete ($450) and savings no longer required ($1,300), at least $3,000 in costs would be eliminated.

If she cut back her entertainment and travel, food and restaurants, clothing and grooming and cellphones expenses by one half and if she replaces her current vehicle with a cheaper model once the lease expires, she could bring her spending down below $7,000.

“She could have a condo and the present cottage, travel and dining, and other creature comforts. And she’d be financially secure,” Moran concludes.

SHE COULD HAVE A CONDO AND THE PRESENT COTTAGE, TRAVEL AND DINING.