Couple needs to see big picture
SITUATION Couple who moved to Canada from Guatemala in 2000 with $15,000 has grown their net worth to $440,000. Can their work pensions let them retire by the time they reach age 55? STRATEGY Sell money-losing condo, use equity to pay down home mortgage.
Acouple we’ll call Roberto and Maria, each 49, came to Canada from Guatemala in 2000 with their two children then 4 and 9. In the late 1990s, the country had the highest murder rate in Latin America. They chose to give up the palms and lavish villas that are part of middle-class life in that country for the snowstorms and security of Canada.
They found jobs in Ontario that made use of their business skills. Roberto works for a local government; Maria for a manufacturing company. They came with $15,000 in their pockets. Their net worth is now almost $440,000.
They have made a terrific success of their lives in Canada. Yet the process of creating secure futures for their children has in turn left them with complex finances and a need to create a path to the time that they will no longer work. Their problem: though their elder child, now 22, is in university and the younger, now 17, about to start post-secondary studies, they are so locked into survival mode that they cannot see the end of what they have striven to achieve.
“We are concerned that we are working so hard that we have no time or money to enjoy life,” Maria explains. “We want to plan a retirement, but we are not sure when we can do it. That is our dilemma.” Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Roberto and Maria. His view is that the tension in their lives — a desire to do well in their adopted country versus their wish to be able to relax and enjoy life — can be resolved.
Investments
The first step is to make their investments more profitable, Mr. Moran says.
Roberto and Maria have a rental condo which generates $650 in rent for one room each month and provides free rent in another room for their elder child still in university. The theoretical rent is therefore two times $650 or $1,300 a month.
The total cost of operation is $601 for interest ( but not principal) on the mortgage, $193 for taxes and $677 for utilities and condo fees, leaving theoretical return of minus $ 17 1 dollars a month.
This may not be too much as a subsidy for their son, but the cost could rise with interest rates. Moreover, with condo prices near record highs, a case can be made for selling. It would be financially efficient to sell and cut losses, but there are other issues.
We want to plan a retirement, but we are not sure when we can do it. That is our dilemma
One might say that paying a subsidy for a child’s residence is not unusual nor wrong, but in this case, the condo is a special situation. It is by far the couple’s largest investment. Their equity in the condo, $97,378, is more than the combined value of their nonregistered investments, RRSPs and TFSAs.
RetIRement plans
If Roberto and Maria do sell, they could liberate about $80,000 of equity after 6% selling costs. The money could be used to pay down their own house’s $260,586 mortgage to $180,586. That would cut amortization at current interest rates from the current 10.5 years to 7.25 years and save $29,300 of total interest.
In preparation for retirement, Roberto and Maria can stop making RESP payments at the end of this year and add the $209 they pay each month to their mortgage payments or general savings. The RESP will then have approximately $37,000 by year-end, which will be sufficient for the children to pay tuition and books for a total of six years of postsecondary education. The children can make up any shortfalls with part-time or summer jobs.
Roberto has staked his retirement plans on the defined-benefit pension plan his employer offers. If he retires at 55, his pension would be $24,000 a year to 65 and then $17,000 thereafter.
He can’t afford this option. If he retires at 60, his income to 65 would be $46,000 a year to 65 and $36,000 thereafter. This is workable, but just barely. The couple would have to scrape by every month. To maintain his way of life even without debt service and retirement savings, he should work to 65, Mr. Moran suggests.
In retirement at age 65, Roberto would have a $50,000 annual employment pension.
Maria could expect a pension of $27,300 based on combined employer and employee contributions to her defined-contribution plan. The plan is not formally indexed. However, if her pay and RRSP contributions follow inflation, then there would be a form of cost of living adjustment, Mr. Moran notes.
Roberto has earned 34% of Canada Pension Plan credits to date. If he works to age 65, he would have 74% of maximum $12,150 annual credits, or $8,990 a year. Maria should have 52% of maximums credits by the time she is 65, so her CPP payout would be approximately $6,300 a year.
Their combined RRSPs, now $61,000, would grow to $114,400 by their age 65, assuming they continue to add $816 a year and obtain a return of 3% over the rate of inflation. At 65, the accounts would yield $7,685 for 20 years.
Their total retirement income in 2013 dollars at age 65 would therefore be $77,300 from work pensions, $15,290 from CPP and $7,685 from their retirement savings for total income of $100,275 before tax.
After some pension splitting, they could pay 25% average tax, and have about $6,300 a month to spend in 2013 dollars.
Their Old Age Security payments at age 67 would allow for 77% of the present $12,150 for each person for what will be 31 out of 40 required years for full OAS benefits, currently $6,553 a year. Their combined OAS benefits would therefore be about $10,160 a year and push their pre-tax total retirement income to $110,435, or about $6,900 per month after 25% average income tax.
Their expenses in retirement would have declined to $ 4,000 from $8,000 a month today. They would have ample and sustainable income for their retirement, including, perhaps, a winter vacation home in the tropics if they feel it is safe to return.