Plan to continue mortgage payments into retirement is a risk worth insuring

ANNUAL DEFINED-BENEFIT PENSION OF UP TO... $70,219

Acouple we’ll call Roberto, 35, and Tessa, 45, are raising two children ages three and four in Ontario. Roberto is a machine inspector and Tessa is a provincial civil servant. They bring home $7,700 per month after tax and add $560 from the Canada Child Benefit — total $8,260. They have just bought a $714,000 house with a $150,000 down payment. It seems an orderly life, but there are complex financial issues for their retirement.

Tessa expects a defined-benefit pension with gross monthly payments between $4,834 and $5,732 per month, depending on when she retires. Roberto is a new Canadian. He arrived in Canada in 2018. Their issues — when they can afford to retire, how much they can put into and get out of their kids’ Registered Education Savings Plans for post-secondary education, and whether it will be feasible to live part time at very low cost on an inexpensive island.

Family Finance asked Owen Winkelmolen, head of Planeasy.ca, an advice-only planning service in London, Ont., to work with Roberto and Tessa.

SAVING AND SPENDING

The planner notes that current allocations, $8,322 per month, include $1,500 rent which will end when the couple moves to their new house. But they will incur $2,700 in new monthly mortgage payments and perhaps $800 monthly for heat, water, property taxes and the other costs of ownership for a net increase of $2,000 in spending. Take off $3,214 current savings and their actual outlays are $5,108 now, due to rise to $7,108 with these adjustments. That will be within their take-home income.

They should be able to double annual RESP savings, currently with a balance of $4,724, to make use of the annual maximum of $2,500 per child to qualify for the Canada Education Savings Grant. That would attract the lesser of $500 or 20 per cent of contributions per child per year to lifetime maximum for the Canada Education Savings Grant of $7,200 for each child. Assuming three per cent annual growth after inflation, the total family CESG will have a value of $100,000 and provide each child with $12,500 per year for four years, Winkelmolen estimates.

Should Tessa contribute to her RRSP? It’s a dilemma, for she will have a defined-benefit pension of as much as $70,219 per year. Adding in investment income, OAS, CPP, etc. RRSP income could push her into OAS clawback territory that begins at $79,054.

She is currently in a 33.89 per cent marginal tax bracket. Add in the 5.7 per cent clawback adjustment on the Canada Child Benefit, a progressive income adjustment that cuts the CCB as family income rises, she is in a 39.59 per cent marginal bracket.

This makes RRSP contributions attractive. She can make the most use of her RRSP by making a one-time contribution of $34,175 from cash and savings this year. She will get back $13,529 in tax refunds and have increased CCB payments next year. The contribution should go to a spousal RRSP Roberto, for he is in a lower tax bracket, Winkelmolen notes. With pension income splitting and the spousal RRSP, they will be able to minimize income tax when retired.

RETIREMENT BUDGET

Roberto and Tessa want to be able to spend $60,000 per year when retired. Living at low cost in a warm spot for a few months of the year will cut some costs, but their mortgage payments will run to Tessa’s age 72. That is 12 years past her target retirement date and seven years past Roberto’s. Their total annual mortgage payment of $32,400 per year will push their $60,000 estimated living cost to $92,400 after tax.

It’s a lot, but it is doable. With a $34,175 RRSP contribution this year, the couple will have $46,460 in their two RRSPS and in Roberto’s defined-contribution pension plan. It will grow with $2,400 annual contributions matched by his company. The annual contributions, $4,800 total growing at three per cent after inflation for 13 years to Tessa’s age 60 will have a value of $142,912. After making withdrawals for the down payment next year their TFSAS, recently $98,421, will have a total value of $58,644. They can add $12,000 per year. In 13 years with three per cent returns compounded for the period, the TFSAS will have a value of $273,534.

At age 60, Tessa can retire with a $70,219 pension including a bridge. Roberto will still be working at $52,285 per year. Allowing for splits of pension income for tax purposes and assuming an 18 per cent average tax, they will have disposable income of about $100,450 per year. That would let then meet their $60,000 spending goal and pay $32,400 on their mortgage, the planner estimates.

Five years later, Roberto can start retirement. Even with suspension of contributions for those five years, RRSPS including defined contribution plans will have grown to $187,877 and will provide annual taxable income of $8,489 for 35 years. Tessa’s pension will lose her $8,700 annual bridge, but she’ll gain $15,437 from CPP and $7,384 from OAS. Their TFSAS will have grown to $380,810 and provide annual non-taxable income of $17,200 for 35 years. Their mortgage payments will have ended. Their retirement income will be $110,029 before tax. After 16 per cent average tax but no tax on TFSA withdrawals, net income will be $95,176. That will cover living costs and mortgage payments.

After 10 years when Tessa is 75 and Roberto is 65, his CPP and OAS will start, he’ll have 33 years of residence out of 40 required for full benefits, so his OAS will be $6,187. He will have an estimated $8,285 CPP. That would lift retirement income to $124,500 before tax. Assuming a 17 per cent average tax rate but no tax on TFSA cash flow, they will have about $106,260 per year to spend. With no mortgage payments, their costs will be $60,000 per year. They will have a $46,200 annual surplus.

LATE LIFE DEBT

The consequence of carrying a mortgage into retirement is they could be in declining health. For now, they have a good disability plan and good dental/medical benefits. So much is dependent on Tessa’s income that even with job-based life insurance, the surviving spouse and kids could be squeezed. The couple should shop for additional term life insurance, Winkelmolen suggests.