PENSION INCOME AND SAVINGS WILL MAKE UP FOR CARRYING MORTGAGE INTO RETIREMENT
STRATEGY
ADD UP FINANCIAL RESOURCES AT PLANNED RETIREMENT IN 11 YEARS, CONTROL EXPENSES
In Alberta, a couple we’ll call Gerry, 44, and Nancy, 37, are raising two children, one eight years old, the other seven months. They have $ 12,323 monthly take- home income consisting of $ 10,636 of salaries from administrative jobs with a large company and modest rental income, but they worry that their debts — $740,539, most of which is from mortgages totalling $727,480 — and their heavy expenses will impair their retirement.
“I struggle with the idea of staying in my job to 55 years of age,” Nancy says. “We want challenges, but can we risk our jobs to pursue them?”
Family Finance asked financial planner Rod Tyler, head of the Tyler Group in Regina, to work with the couple. His view: Sticking with their careers will provide ample retirement security
FINANCIAL RESOURCES
To examine their options, Tyler broke down the couple’s income into take- home wages, $10,636 a month, net rental income of $325 on a property in which they have $ 125,420 equity, and miscellaneous investment income of $ 1,362. The return on the rental property’s equity is three per cent a year before tax. They are left with perhaps $ 3,000 a year after tax and that’s without allowing for repairs or vacancy. Their mortgage runs for 27 more years to the time Gerry is 71 and Nancy is 64, both well into a planned retirement. They could wind up using retirement income to support the rental property.
Their equity in the rental amounts to about half of their income-producing assets. They could adjust the mortgage cost with a flexible mortgage that allows for home equity loans, but the long- term prospects are dim. Their present 3.08- per- cent interest rate will rise one day. They might be able to raise rent, presently $ 2,150 a month, to accommodate the higher rate, but a rise in their mortgage rate to five per cent would wipe out their nominal cash flow from the property.
The conservative thing to do is to sell the property for its estimated price of $375,000. After selling costs of five per cent, they would have $ 356,250. If they then paid off the $ 249,580 mortgage, they would have $ 106,670 for other investment. If rolled into their TFSAs over time to fill their past contribution space and to support future contributions within the $5,500 annual personal limit, they could have five per cent a year from dividend- producing stocks or from a dividend- focused exchange- traded fund. That would be two- thirds more than their present three- per- cent return from the rental property. They would have their own home with a $540,000 estimated value, asset diversification and shelter from taxes on appreciation of their home.
EDUCATING THE CHILDREN
Gerry and Nancy have two Registered Education Savings Plans, one with a $2,130 balance for their seven-month-old and another with a $22,000 balance for their eight-yearold. The parents contribute $ 258 a month, $ 3,096 a year. They can find more RESP money by cutting their “miscellaneous” spending of $322 a month to raise the RESP contribution to $416 a month. If they put in $ 2,500 per child each year, they will qualify for the Canada Education Savings Grant maximum top-up of the lesser of $500 or 20 per cent of sums contributed. CESG top-ups stop at the end of the child’s 17 th year. The RESPs can grow at three per cent a year to $65,704 for the younger and $60,100 for the elder, all in 2016 dollars. The parents can easily average out the two to give each child about $ 63,000 for post- secondary education.
PENSIONS AND SAVINGS
Gerry and Nancy are 11 and 18 years from retirement, respectively. Each will have a company pension set at two per cent of the average of their final five years of gross salary, multiplied by their years of service. Given Nancy’s desire to find more challen- ging work, her tenure may not last to 55, her anticipated retirement age. However, we’ll assume that she and Gerry will each have 25 years of service when Gerry is 55. That would give each a company pension of 25 times two per cent of $99,600 current gross salary maintained in 2016 dollars, for a base pension of $ 49,800. Total pension income would be $99,600 before tax.
Gerry will be 55 in 11 years. The couple has $ 97,200 in RRSPs. They contribute $ 1,000 a month. If they obtain a three- percent return after inflation for 11 years on present funds, plus $ 12,000 annual contributions, they would have $ 293,000 when Gerry retires and, presumably Nancy follows or ends her own alternative occupation. An annuitized payout calculation would give them $ 12,300 for 40 years to Nancy’s age 95.
The couple’s TFSAs have a present balance of $ 28,000. They contribute $ 975 a month or $11,700 a year, slightly more than the revised $ 5,500 personal annual limit. They should cut $700 out of contributions to stay within limits. In 11 years, when Gerry is 55, the two plans would have $183,900. That sum, at three-per-cent annual return, would generate $7,700 annually for 40 years starting at Gerry’s age 55.
Their total retirement income from pensions, RRSPs and TFSAs would be $119,600 before tax. If incomes are split and taxed at an average rate of 20 per cent, they would have $7,975 a month to spend.
RETIREMENT
At 65, depending on their tenure and what work Nancy may do, they can have what we’ll assume will be 70 per cent of the maximum $13,110 CPP benefit each, a reduction reflecting their early retirement, adding $ 18,354 to gross income and pushing it to $ 137,954 a year, or $ 9,200 a month after 20 per cent average tax in 2016 dollars. Finally, there would be annual Old Age Security benefits of $6,846 each in 2016 dollars. That would lift total income to $151,646 and make each person’s income $ 78,323 before tax, vulnerable to the clawback, which currently begins at about $ 73,000 a year. The clawback would reduce final income by about $400 for each partner.
That would leave final income at $10,060 a month after 20- per- cent tax with age and pension credits, the precise amount being determined by any dividends from Canadian corporations received outside of registered plans or TFSAs. Those dividends inflate tax exposure before the dividend tax credit is applied.
Their present expenses, $12,323 a month, will decline in retirement. Their mortgage, with a 26- year amortization, will be paid off, assuming no changes in interest rate or payments, when Gerry is 70. That’s well into retirement, but easily within the couple’s means. Their car loan will be paid before 2018, and there would be no child- care cost, no retirement savings, RESP contributions or other debt charges. Expenses in retirement might be cut by $5,000 to about $6,000 a month.
“Our projections allow the couple to be mortgage free late in life and to have an enviable level of financial security,” Tyler concludes.
‘OUR PROJECTIONS ALLOW THE COUPLE (HOPING FOR EARLY RETIREMENT) TO BE MORTGAGE FREE LATE IN LIFE AND TO HAVE AN ENVIABLE LEVEL OF FINANCIAL SECURITY.’
— FINANCIAL PLANNER ROD TYLER, HEAD OF THE TYLER GROUP IN REGINA