Loss of disability cheques at 65 threatens couple’s retirement plan
In Ontario, a couple we’ll call Hilda, who is 55, and Felix, who is 60, are migrating toward full retirement. But there are bumps ahead. Felix has been on disability for many years with respiratory issues. Hilda is an administrator in information technology with $2,000 monthly income before tax. After tax, they take home about $6,000 per month. The worry that their way of life will crumble when Felix’s disability insurance ends at age 65 and he loses half their monthly income.
Felix’s pre-tax disability income, now $4,454 per month, consists of $3,200 a month from the company plan and $1,254 from CPP disability. The CPP portion will be replaced by regular retirement benefits of an estimated $1,037 a month in 2017 dollars. His Old Age Security at 65 at $584 per month will help, as will monthly rental income of $330, it will be tight. Income has to go up and some costs, such as debt service, have to go down.
“Could we retire earlier than when I am 65?” Hilda asks. “To do that, would we have to sell our house and move into a condo?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Hilda and Felix. “They don’t have a lot of capital, but they do have so many sources of income that they can make their retirement work,” he explains.
Neither Felix nor Hilda has a job pension. Adding to the problem is that 58 per cent of their net worth is tied up in their $1 million house. A rental condo produces net income after borrowing and other expenses of $3,960 per year. That’s a 6.6 per cent return on their $60,000 equity based on $200,000 borrowed on the investment, Moran notes.
If the $650,000 now in their RRSPs were annuitized immediately with assets continuing to generate 3 per cent after inflation, it would sustain an income of $33,160 in 2017 dollars before tax for 30 years, that is, to Hilda’s age 85. They would still have their $1 million house that could be sold. Timing retirement is the issue, Moran explains. Felix could take CPP early, but it makes no sense for him to do it. His monthly CPP disability payments would be replaced by CPP discounted by 36 per cent if he starts at 60. Hilda could take her CPP at 60 as well, but she, too would take a 36 per cent loss of the age 65 benefit.
Hilda and Felix have many choices of timing their retirement and adding to assets by selling their house or condo. The baseline income number is what they need to retire. Current allocations, which include debt service, of $806 a month would be the initial target.
If Hilda were to retire immediately, the couple’s income would be $90,568 a year before tax consisting of Felix’s disability benefits of $53,448 a year, $33,160 RRSP cash flow before tax and $3,960 rental income. After 20 per cent average tax, they would have $6,040 a month to spend, about equal to present allocations. The future is the problem.
At 65, Felix will lose his company disability pension. His $12,444 CPP retirement benefit would replace the disability income. OAS would add $7,004 a year and rental income would be $3,960 a year. RRSP income would add $33,160 a year for total income of $56,568 a year. With splits of eligible pension income and age credits, they could pay an average 13 per cent and have $4,100 a month to spend, far below present allocations.
RAISING RETIREMENT INCOME
They could sell the rental condo, harvest the difference between its $260,000 value and the $200,000 they owe and put the money into a TFSA. Neither Hilda nor Felix has a TFSA. Each has $52,000 of space. If they can get $60,000 in the currently hot market and they obtain 6 per cent per year with no inflation adjustment, it would generate $3,600 a year, a little less than the $3,960 the condo yields but with no tax on the TFSA cash flow. However, if interest on the condo loan, now 2.77 per cent, were to rise to 4.76 per cent when they renew the mortgage, the profit would be wiped out. In time, it could happen, Moran adds.
Alternatively, if they were to sell their $1 million house immediately and move into their condo after paying off its $200,000 mortgage and some tax triggered by the end of renting and the $100,000 line of credit, they would have Felix’s $53,448 total disability income, RSP income of $33,160, and taxable investment income of $33,170 a year from cash from the house sale assuming they got $950,000 after commissions and costs, paid their $300,000 of liabilities and invested the balance of $650,000 at 3 per cent after inflation for 30 years. The sum would be about $119,800 a year or $7,985 a month after 20 per cent average tax. They could support present spending quite easily even when the company disability cheques are replaced by $12,444 total CPP retirement benefits at 65, Moran notes. Debts will have been paid in full so that $806 of mortgage and line of credit bills would have ended.
At Felix’s age 65, his disability cheques would stop and be replaced by $12,444 annual CPP retirement benefits He would have $7,004 annual OAS benefits. Assuming that Hilda has also retired, their income would be about $85,778 a year before tax or $6,290 a month after 12 per cent average tax. However, with all debts paid, $9,672 of annual debt service would stop.
At 65, Hilda could add her OAS benefit, $7,004 a year, and projected CPP benefits of $8,400 a year, boosting income to $101,180 a year. After 15 per cent average tax based on age and pension credits, they would have about $7,170 a month to spend. “The basis for a secure retirement is in place,” Moran says.