Retirement at 50 will challenge couple’s high savings rate
A couple we’ll call Phil and Robin, both 41, live in Ontario. Phil, a skilled tradesman, brings home $6,600 a month, Robin, an administrator in a local business, brings home $2,800 a month. They are frugal with no debts other than a $225,000 mortgage on their $350,000 house. They have no children. Their challenge — retirement as early as age 50 with income of $60,000 per year before tax. The issue — how much will ending their careers hurt their plans?
“We save a lot, about 40 per cent of our after-tax income,” Phil explains. “We work long days, but if we can retire at 50, we would have stress-free lives and time for travel. The question is whether we can make it happen.”
Family Finance asked Benoit Poliquin, chief investment officer of Exponent Investment Management Inc. in Ottawa, to work with the couple. “Retirement at 50 will deprive them of a critical decade or more of earning and saving and force them to stretch their savings that much longer,” he explains.
PORTFOLIO MANAGEMENT
Phil and Robin are experienced investors. They use low fee exchange traded funds with average annual returns for their portfolios of about six per cent for the last five years. However, they assume inflation will run at two per cent for the indefinite future. Three per cent is the historical average. Poliquin says. Over a period of as many as six decades of generating retirement capital and spending it, one per cent of inflation makes a big difference. We’ll use three per cent.
Phil and Robin have $531,500 of financial assets. $56,500 is in defined contribution pension plans, $390,000 is in Registered Retirement Savings Plans and $85,000 is in Tax-Free Savings Accounts.
Phil and Robin contribute $21,600 a year to their RRSPs per year. The RRSP balances of $390,000 will have $728,300 at their age 50. That sum, paid out in full over the next 45 years while still earning three per cent after inflation would generate $28,840 per year in 2017 dollars.
The couple’s Tax-Free Savings Accounts with present balances of $85,000 soon to be bumped up to the present maximum limit of $52,000 each, $104,000 total, growing at the allowed rate maximum of $5,500 per person for nine years to their age 50, would have future balances, calculated at three per cent annual growth after inflation, of $251,000 and be able to support payouts of all income and capital in the following 45 years of $10,000 a year.
RETIREMENT INCOME OUTLOOK
Before their company defined benefit group plans, which are like RRSPs, begin payouts as early as age 55, Phil and Robin would have combined pre-tax investment income of $38,840 a year. That sum, after 9 per cent average income tax, would leave them with $35,344 a year. It would have to support $48,000 annual spending with elimination of one car and all savings. The gap would have to be closed with either part time work, a delay in retirement or appreciably higher returns from invested assets. It is far from their age-50, pre-tax goal.
When they reach 55, Phil’s defined contribution work pension can start paying him $1,600 per month while Robin can expect $800 per month from her defined contribution pension. Their total income would then be $5,636 before tax each month, below present spending of $5,700 with all savings removed.
At age 60 each could start Canada Pension Plan benefits at 36 per cent discount from the $930 per month each could expect at age 65. Each would then take a $335 loss and get $595 per month. The cost would be the theoretical loss of $120,600 each in 2017 dollars for 30 years after age 65. Dying sooner than 95 would reduce the theoretical loss, of course. But early CPP benefits at 60 would close the spending gap.
At 65 without an early start, they would have two CPP benefits which would total $22,320 per year and two Old Age Security benefits of $7,004 each per year. If nothing else changed, their age 65 income would then be about $104,000 per year before 15 per cent average tax, leaving them with $7,370 a month for expenses that could have declined to perhaps $5,800 per month with elimination of all savings, a car payment and half of present car operating expenses and insurance if they can get by with one vehicle.
CLOSING THE GAP
The five year gap from 55 to 60 remains the critical breach in the couple’s retirement plans. They consider selling their home after elimination of the mortgage and harvesting perhaps $100,000. If in five years — disregarding higher interest rates that may take effect along the way and assuming house prices do not change — the mortgage debt will be down to perhaps $150,000, they would have equity of $200,000. They could take the money and use it to rent. On that basis, the money still generating 3 per cent a year after inflation would provide $500 a month before tax for rent. That is unrealistically low. Staying put and doing some part-time work to generate supplemental bridge income would be the wiser thing, Poliquin suggests.
Early retirement would be more feasible if their mortgage was eliminated. They have the discretionary savings to accelerate payments. They would save interest of 2.49 per cent per year. They pay in after tax dollars, so the true cost is about 4 per cent in the dollars they earn.
“Timing retirement to begin at 50 means they are predicting investment returns for a specific time window. Calling the shots for a specific term of five years before CPP and OAS start is chancy.”
“A few years more of work or some part time work in the first five or more years of retirement is going to be essential,” Poliquin says.