Couple who paid for kids’ education now grappling with big mortgage debt
In Ontario, a couple we’ll call Helen, 60, and Jerry, 63, are retired. Helen left an administrative position with a financial services company. Jerry has been retired for many years, a casualty of the bankruptcy of his former employer in 2012. He did not find comparable work in his field of information management and was forced into premature retirement. Today, they live on $5,440 per month from Helen’s pension, Jerry’s Canada Pension Plan benefit and retirement assets. The kids, now in their 20s, remain at home. Their dilemma: maintaining their way of life on what they worry is inadequate income.
On paper, Helen and Jerry are prosperous. Their house has an estimated value of $1.5 million, they have $540,000 in RRSPs, $105,000 in TFSAs and $20,000 in taxable investment accounts. Their net worth, including cars and accounting for their $300,000 home mortgage, is $1,877,000.
But with 80 per cent of that tied up in their house, the couple needs to determine whether they will have enough income during their retirement, says Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C.
INCOME QUESTIONS
Currently, Jerry gets $6,000 a year from the Canada Pension Plan, while Helen has a $31,000 work pension including a $4,000 bridge to age 65. They are drawing $39,000 from their RRSPs, making their total income $76,000 per year before tax.
The y spend about $65,000, including $16,800 to service their mortgage. At this rate, the mortgage will not be paid until 2044 when Helen will be 85 and Jerry 88.
There is a backstory to this predicament. The couple has a late-life mortgage because they sent their children, now in their mid20s, to private schools and paid their university costs. As a result, the kids have no education debts — but the parents have a big debt in retirement. On top of that, the kids are still living at home.
More cash and less house would give Jerry and Helen more financial security, Moran explains. “Moreover, selling the house would give the kids a nudge to move out,” he says. “They should have independent lives.”
A DOWNSIZING OPTION
Were they to sell their house and buy something downmarket, they might cut costs. If the replacement house costs $1 million, then a sale at $1.5 million less selling costs and pre-payment of the mortgage would eliminate present mortgage costs and reduce property taxes. Their total costs would drop by 26 per cent on debt service alone for they would be saving the present mortgage cost of $1,400 per month. Add reductions to property tax and other bills and their total cost of living might be a third less, Moran explains. This is an “if ” and not a necessity, so we are not including a sale or investment revenue in projections.
Another option would be for Helen to opt to receive CPP benefits before 65, but that is not necessarily a good idea. She would pay a penalty of 7.2 per cent per year for each year before 65 that she starts benefits. The funds she receives from CPP, which count toward total income, would be taxed at about 13 per cent. Her best bet is to wait until 65, Moran suggests.
We can look ahead five years when Helen’s job pension, currently $31,000 per year, drops to $27,000 per year. Her Canada Pension Plan benefits will start flowing at a rate of $11,904 per year. Jerry took CPP early at $6,000 per year.
Each partner will have lived in Canada for the 40 years after age 18 required to receive full Old Age Security benefits, currently $7,217 per year.
PENSION PLANNING
Their RRSPs, a total of $540,000 at present, growing at 3 per cent after inflation, spent over the next 30 years to Helen’s age 90 would provide an indexed income of $26,750 per year in 2019 dollars.
The couple’s tax-free savings accounts, with a current balance of $105,000 growing at 3 per cent after inflation, will provide a stream of $5,200 per year for 30 years. The couple could cash out this account and use the money to pay down a third of their outstanding $300,000 mortgage. But the assets in the TFSA have a dividend rate, about four per cent, plus prospects of appreciation of a few per cent per year. The best bet is to leave the mortgage as is and keep the TFSA intact for drawdowns over the next 30 years.
There is a $20,000 balance in the couple’s taxable investment account. We’ ll leave that in place for emergencies and buying a new or newer car to replace their two old cars.
Before Helen is 65, the couple’s income will consist of her $27,000 annual work pension plus the $4,000 bridge to 65, Jerry’s $6,000 Canada Pension Plan benefits, RRSP withdrawals totalling $26,750 per year and combined partners’ TFSA withdrawals totalling $5,200 per year. The total is $68,950. With splits of eligible income and tax at a rate of 13 per cent with no tax on TFSA withdrawals, the couple would have $5,100 to spend each month. That will almost cover expected expenses of $5,440 per month. A few spending cuts for a few years would match income to expense.
When Helen and Jerry are both 65, the picture changes. Helen loses her bridge, so that her base pension falls to $27,000 per year. She can begin to take CPP benefits at $11,904 per year. Jerry’s CPP benefits will remain at $6,000 per year. Old Age Security for both will add 2 x $7,217 or $14,434 at current rates. Their RRSPs will yield $26,750 and their TFSAs will produce $5,200 per year. All that adds up to $91,288. After splits of eligible income and removal of TFSA proceeds from tax calculations, they would pay tax at an average rate of 15 per cent and so have $6,530 to spend each month.
“The parents have been generous to their kids, but they can still retire comfortably,” Moran concludes. “If they maintain their way of life, their financial assets, CPP, OAS and Helen’s pension should be adequate.”