MILLENNIAL COUPLE HAS ENVIABLE PROBLEM OF WHERE TO PUT SAVINGS
In Saskatchewan, a couple we’ll call Eric, 30, and Jessica, 28, have been married for five years. Both work in the transportation industry as vehicle dispatchers. Their take home income, $7,933 a month plus $750 for renting out a suite in their home, a total of $8,683 a month, provides a good living in a town where house prices today are what prices in Toronto and Vancouver were generations ago. Their dilemma — where to put savings?
“We are not excessive spenders nor are we excessive savers,” Eric explains. “Our employers have no pension plans. Should we focus on paying down the mortgage or put more money into RRSPs? I don’t even have one and my wife’s is quite bare.”
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Eric and Jessica. She notes that their modest cost of living allows them to save $2,600 a month. For the eight month balance of 2017, they will therefore save about $20,800 and $31,200 for the full year in 2018.
“Their high savings rate is the good news,” the planner says. “However, they have an outstanding mortgage balance of $353,000. For now, with no children in the immediate future, it is possible to make use of their savings to create future value for living and for retirement.”
Financial predictions that cover 30 years or more of saving and another 35 years of drawdowns after that are speculative by definition.
Yet the exercise does provide what financial analysts call boundary conditions, that is, the best or worst outcomes for given assumptions.
DEBT AND SAVINGS
Their mortgage has a 2.99 per cent interest rate with a 25-year amortization. They pay $ 1,800 each month. If they accelerate paydown by making an extra annual $ 5,000 payment on the mortgage, it will be paid off by the time Eric is 47, a reduction of the present schedule that will make the couple mortgage free when he is 65.
Next move — put $6,500 into an RRSP for Eric, who does not have one at present.
Then add $ 3,500 to Jessica’s modest RRSP. She, like Eric, has a 34 per cent marginal tax rate, so the savings will be about $2,200 for Eric and $1,200 for Jessica.
Finally, put $ 7,500 for each, $15,000 total, into TaxFree Savings Accounts. Neither partner has one now.
With these moves done over the course of the year, they will have made use of $18,000 current cash savings and much of their savings to come in 2017 and 2018. In all, $30,000 will have been used for investments and debt reduction.
FAMILY AND FUTURE
If they do not have children, the money they would have set aside for kids’ cost of living and education will be available for their retirement. Their present mortgage with accelerated payments will be eliminated in 18 years. The money they now shovel into the mortgage, $ 1,800 monthly with no accelerated payments, or $21,600 a year, will be avail- able for retirement savings. Assuming six per cent total annual return less three per cent for inflation, with $21,600 of combined annual savings for 17 years from the end of the mortgage to Eric’s retirement at 65, they would have non-registered savings of $484,150. Annuitized for the next 32 years to Jessica’s age 95, this capital would generate $ 23,800 a year in 2017 dollars assuming a three per cent return after inflation.
Their two TFSAs, starting from zero balances in the near future and enhanced with the suggested contributions of $7,500 each and growing at $5,500 per year for each would have combined balances in 35 years of $727,000. Annuitized to pay out all income and principal in the next 32 years to Jessica’s age 95 with a three per cent growth rate after inflation would generate $34,600 per year in 2017 dollars. This is, one should note, merely a calculation, not advice to buy an annuity. Annuities sold by insurance companies are based on government bonds and, with interest rates still very low, they pay little. In effect, they tie up a great deal of money to pay out very little.
Their RRSPs, $ 4,400 at present and growing with what we can assume will be contributions of $ 1,000 a month each for 35 years to Eric’s age 65 would add up to $1.5 million on a combined basis assuming a three per cent annual return after inflation. Annuitized for 32 years to Jessica’s age 95, the money, paid out in RRIFs, would generate $73,500 per year.
Add in assumed full Canada Pension Plan benefits of $13,370 each at 2017 rates for Eric and Jessica, full Old Age Security benefits at 65 of $6,942 for each at 65 and add in present rental income $750 per month, $9,000 per year, and they would have total pre-tax income of about $181,500 a year. With splits of eligible pension income, no tax on $34,600 of TFSA income and application of today’s age and pension credits, they would not trigger the OAS clawback that presently starts at about $74,000 of income. On their taxable income (everything but the TFSA payouts), they would pay tax at an average rate of 20 per cent and have about $12,700 per month to spend in 2017 dollars.
ALTERNATIVES
The annuity calculation, which is just math and not a suggestion to buy an annuity from an insurance company, starting at Eric’s age 65 could be replaced by deferring the RRSP payout via a Registered Retirement Income Fund starting to pay out when Eric is 72. His first annual withdrawal would be at 5.4 per cent of his account’s value, then about $1,853,000 in 42 years with growth at three per cent in 2017 dollars with $24,000 annual contributions for 35 years, then seven years of growth with no contributions. At that time, payouts would be $99,600 per year.
Alternatively, they would have the option of spending RRSP or TFSA money from Eric’s age 65 in order to preserve full CPP benefits and their indexation. If he can postpone the start of CPP to age 70, Eric would get a 42 per cent premium over the age 65 payout.
With steady contributions to registered and non-registered savings and no children, the savings and retirement incomes in this analysis are feasible. Kids, however, would change the equation.