Couple needs to ratchet up their savings plan
An Ontario couple we’ll call Charlie, 39, and his wife, Robin, 33, have solid careers, his as a health-care professional, hers as a manager in a financial institution. Together they bring home $9,700 a month. Recently, they have put down roots in a $645,000 condo. They have an urge to travel, no children, and a wish to retire in 17 years when Robin is 50.
“What steps do we have to take to make retirement happen as early as when I am in my mid-50s?” Charlie asks. “We don’t feel we live above our means, but we also feel we are behind where we should be at this point in life.”
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Charlie and Robin. “The challenges in this case are to find a way to finance an early retirement and a lot of foreign travel. They have not decided if they want to have children. In the meantime, their priority is to reduce their outstanding mortgage and pay off about $67,000 of other loans.”
RETIREMENT SAVINGS
If they contribute $20,000 annually to Robin’s RRSP and can obtain a 4 per cent annual return after inflation, then with her 40 per cent marginal tax rate, she will save $8,000. That tax savings along with the remaining $4,000 of their remaining surplus can then be used to boost mortgage payments, allowing them to eliminate the mortgage, which has a 30 year amortization at present, in just 16 years. At that time, Charlie will be 55. If interest rates rise in the interval, which is likely, termination of the mortgage will be delayed, but focusing on mortgage elimination should be a high priority for the couple, the planner says.
This retirement strategy focuses on reducing mortgage debt relatively quickly in order to reduce total interest over the lifetime of the loan. That money, which otherwise would have been paid in interest, can eventually be directed to savings and then to travel and even the purchase of a South Pacific vacation property.
Favouring RRSP savings over what they may accumulate in their tax-free saving accounts makes sense, for each is in a fairly high tax bracket. By putting most of their spare cash into RRSPs, they get $12,000 a year added to their mortgage. They can also direct the $2,000 a month they have been paying to eliminate a family loan to their tax-free savings accounts once the family loan has been paid off.
With present cash flow, they can save $2,000 a month for the next 16 years. Assuming a 3 per cent return over inflation, they will have grown their combined TFSAs to $303,000 and other savings to $262,000.
INCOME IN RETIREMENT
At age 55, Charlie can receive an unreduced pension of $61,320 per year based on what will be 35 years of work and 2 per cent of his best or final annual salary. He will have an $8,200 annual bridge which will end when he is 65. Assuming that he splits pension income with Robin, they will have net income tax rate of just 12.6 per cent in retirement. Their after-tax income will then be $4,468 per month. Their monthly expenses with all debts paid and savings terminated will decline to $3,692.
Robin’s RRSP will have grown to $475,000. She will have no other income if she retires at the same time as Charlie. If she takes $12,000 a year out of her RRSP, she would pay no tax. The couple’s monthly income would be $5,468. Even with potential annual withdrawals from her RRSP, by age 71, when she has to convert the RRSP to a Registered Retirement Income Fund, the portfolio, assuming 4 per cent annual growth after inflation, $541,000.
At 60, Charlie will be eligible to receive reduced Canada Pension Plan benefits of $8,556. He will not need the money, but if he takes it, he can use it to add to TFSA savings. Alternatively, waiting to age 65 will allow him to “earn” a 7.2 per cent return, which is the penalty for taking CPP at 60. If he defers application to 70, he will get an annual 8.4 per cent bonus. That is risk free and indexed as the CPP base rises. That is a benefit hard to beat in stocks or bonds, both of which come with various risks.
At 65, Charlie’s $8,200 bridge will end and his pension will decline to $53,120. He will be able to take Old Age Security at $7,004 in 2017 dollars per year or to defer it with a 7.2 per cent annual bonus for postponement on top of indexation.
By the time Robin is 71, the couple’s combined income will consist of Charlie’s $53,120 annual pension, his CPP of $8,556, his OAS of $7,004, Robin’s RRIF payments of $28,565 and her Canada Pension Plan payments if, as planned, she stops work and CPP contributions at her age 50, of about $7,000. She would also have OAS benefits of $7,004 per year. The sum of these income sources is $111,249 per year. After splitting eligible pension income and paying 17 per cent average income tax, they would have about $7,700 a month to spend. Their baseline spending would still be $4,515 a month in 2017 dollars.
WHEN TO SAVE AND WHEN TO SPEND
Early retirement means reduced time to save. Making sacrifices in the working years allows for more saving to finance a period with no work for as much as 40 to 45 years. As long as inflation does not raise the cost of travel and the foreign property they would like to buy, the plan will work. Chances are Charlie and Robin, both energetic, focused people, will want to get into some part time work that will both raise income and reduce available leisure time. They may want to consider working with good causes to which they might also donate money. Their issue, more than a financial problem, is what to do with decades of leisure, Ms. Nalbantoglu suggests.