RETIREMENT HOPES HINGE ON FIX-OR-BUY OPTION
A woman we’ ll call Elsie, 45, works for a large information business in British Columbia. Her job supports $ 5,186 monthly take- home pay and she has a tidy sum of investments and cash totalling $ 64,463. She owns her $ 300,000 condo debtfree. Yet Elsie worries that she is not making the most of her retirement savings, company pension and RRSP savings.
Her condo has required a lot of repairs. She received a $ 30,000 bill for exterior work and wonders if she should leave her financial fate to her condo board or buy a house.
“I can buy a house with a mortgage,” Elsie explains. “The interest and principal payments would cost me half my income. Or should I stay put, focus on retirement strategies? That said, when can I retire? Fifty-five, 60 or 65?”
Family Finance asked Graeme Egan, a financial planner and portfolio manager who heads CastleBay Wealth Management in Vancouver, to work with Elsie.
“She has no debt other than a small loan from her parents. Her problem is to make the most of opportunities,” Egan notes. “That is where we have to do our estimates.”
FIX UP THE CONDO OR BUY A HOUSE?
Elsie’s dilemma is whether to add a $30,000 upgrade of her bathrooms or sell and buy an $ 800,000 detached house. The conservative thing to do is to stay put, fix up the place and, if it is done right, add to the value by more than the outlay. The decision is speculative, of course, but a modest outlay and a likely gain in value is less chancy than laying out perhaps two to three times the value of her present condo for a more costly home that could — one never knows — l ose value if the overbought B.C. home market settles down. Were she to use $ 270,000 from the sale of her condo after repairs and selling costs and finance the balance of the price at two per cent for 20 years to age 65, it would cost her $ 2,681 a month. She can afford it by ending savings and cutting back travel spending. It could be tight, however, if interest rates rise. Buyi ng t he house with t he $ 800,000 price tag could jeopardize her ability to retire at 55, Egan says.
Not buying a house and making a huge commitment to a mortgage would allow Elsie to raise her RRSP contributions. Adding to RRSPs saves money at her present tax rate, which will be lower in retirement, Egan notes. She has about $ 44,000 of unused RRSP space. If she switches $ 10,000 from her $ 14,370 Tax Free Savings Account balance to t he RRSP, she would save about $ 2,700 at her present marginal rate, Egan estimates. She has unallocated savings to boost her TFSA balance provided she does not buy a detached house.
BUILDING RETIREMENT INCOME
If Elsie contributes $ 10,000 from her TFSA to her RRSP for a new balance of $ 33,247 and then continues to contribute $ 6,000 per year to her RRSP for 10 years at three per cent per year after i nflation, the RRSP would grow to $115,500 when she turns 55. Annuitized for 40 years to exhaust all income and capital at age 95 with a three per cent annual growth rate within the annuity, it would generate $ 4,850 a year or $404 a month.
If she retires at 55, she could stop adding $ 500 per month to the RRSP and then let the $115,500 grow at three per cent per year for another ten years to $155,225. Annuitized for 30 years, it would provide $7,920 a year or $660 per month.
If, on the other hand, she works to 65 and maintains contributions for 20 years, the RRSP would have a balance of $ 226,100. If annuitized, it would support payments of $ 11,200 a year or $933 a month to age 95.
Elsi e’s work pension would provide $ 3,344 per month at 55 plus a bridge of $ 995 per month to 65, for a total of $ 4,339 per month. She could add annuitized RRSP income.
Given her very modest spending — just $ 2,126 per month at present with all savings and debt service removed, Elsie would have no urgent need to begin CPP at 60 nor OAS at 65 nor even to draw down her savings. The longer she defers using her savings, the more she will have to spend in later retirement and to keep for care should she need it.
TIMING RETIREMENT
What to do? Elsie could afford to retire at 55 using her company pension and bridge, which would total $4,339 a month. After 17 per cent average income tax, she would have $ 3,600 a month to spend.
It would more than cover her expenses and leave room for additional savings. At 65, her company pension plan bridge, $ 995 a month, would end, but her Canada Pension Plan benefits would be similar, the gain almost exactly offsetting the loss of the bridge.
At 70, assuming she works to 55 and does not touch her RRSP until 65, her total monthly income would be $ 3,344 from the company pension, $ 776 f rom Old Age Security if started then, $ 1,393 from CPP starting at 70, and $660 from her RRSP. The total, $6,172 a month or $74,064 annually before tax, would be subject to the OAS clawback of 15 per cent of the amount over the present $72,809 trigger point, would cost a couple of lattes a month. Her income after tax at an average 20 per cent rate would leave her with about $4,900 a month, more than current spending net of savings.
“Her retirement would be secure,” Egan says.
SHE HAS NO DEBT OTHER THAN A SMALL LOAN FROM HER PARENTS.