COUPLE WORRY WHETHER THEY CAN KEEP QUALITY OF LIFE AS RETIREES
An Ontario couple we’ll call Harry, 57, and Priscilla, 55, have been fortunate in their careers. As they approach their seventh decade, they wonder how much of their present income, $9,500 a month after tax plus $1,100 a month of rental income from an apartment in their basement, will be available if they retire when he is 64 and she is 62. They want to spend winters in warm places, summers at their cottage and hope to do it on 80% of their present income.
Priscilla has put in a quarter of a century with her employer, a wood-products manufacturer with a defined benefit pension plan. She takes home $7,500 a month. Harry has a small company that makes toys. He has cut his hours due to severe back pain. He brings home $2,000 a month. The issues: can they maintain their way of life in retirement, especially if Priscilla predeceases him and if, as well, they want another residence in the sun, probably abroad?
With present plans, Priscilla will have a $49,000-a-year pension plus a $19,560 annual bridge to age 62, totalling $68,560. After age 62, her pension drops to $49,000 plus $5,200 a year from a supplement, a total of $54,200 a year. Annual rental income of $13,200 will boost those numbers to $81,760 before age 62 and $67,400 thereafter. Assuming an average tax rate of 12% in either case, they would have $6,000 a month and $4,950 a month respectively. Their current allocations work out to $8,330 a month, net of savings. The gap needs to be closed.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with the couple. “With their present financial arrangements, this couple would not be able to cover their initial retirement costs without dipping into investments until they can get CPP and OAS,” Mr. Moran explains. “But if we plan correctly, they can preserve capital and their way of life.”
CURRENT MONEY MANAGEMENT
On the plus side, their three children are grown and no longer represent financial responsibilities. Moreover, their present expenses will shrink when their outstanding $145,000 mortgage, which costs them $3,280 a month, is paid off. At present accelerated paydown rates, that would be in about four years when Harry is 61.
The first move, Mr. Moran says, is to save money on the outstanding mortgage balance. They have $50,000 in their TFSAs, which they can use to pay down the mortgage to about $100,000, saving $7,400 of annual interest expense. Cashing out the TFSA balance will have no tax consequence, while tapping RRSPs or taxable securities would trigger taxes. The remaining mortgage balance will be gone in 30 months if the paydown rate is not changed. With the mortgage paid off, they can use annual mortgage payments, now $39,360, and their unallocated savings of $1,240 a month, to refill the TFSAs. In 2015, they would each have $36,500 of space, growing at $5,500 per person each year.
The next challenge is to make their retirement income more secure.
Priscilla’s present pension arrangement gives Harry 60% of her amount should she predecease him. It would be better to select the 100% choice, which would drop her base pension rate to $33,200 a year. The $5,200 supplement would make her total pension income with this option $38,400 a year.
To make up the difference between the $49,000 plus bridge with the 60% survivor option and the $33,200 plus bridge she can have with the 100% survivor option, Priscilla and Harry can increase their savings. At present, they have $236,000 in RRSPs. If they continue to add $600 a month to their RRSPs and the money continues to grow at 3% a year after 3% inflation, they would have $320,000 when Priscilla is ready to retire late in her 62nd year.
There will be no need for Harry or Priscilla to rush to take Canada Pension Plan benefits before 65 with a penalty of 7.2% of the amount for each year before 65 that benefits start. Assuming that Priscilla gets the maximum benefit, currently $12,460 a year, and Harry 70% of that, or $8,722 a year, they will have total annual CPP income of $21,182. Their total income after Harry’s age 65 would be $38,400 from Priscilla’s pension and supplement after 62, $13,200 from rental income, $18,500 from annuitized RRSP investment income, and $21,182 from CPP for gross annual income before tax of $91,282. Add two Old Age Security cheques of $6,765 a year each and their total annual income would be $104,212 before tax.
If that sum is split and taxed at an average rate of 16%, they would have total disposable income of $7,300 a month and would be able to cover present allocations net of the paid-off mortgage cost, discontinued RRSP contributions and other savings, which total $5,050 a month.
Income from TFSA savings, which have not been part of this calculation, would add untaxed potential income of perhaps $4,450 a year, or $370 a month, if the couple restore the TFSA balance and maintains the $5,500 annual contributions each to the time Priscilla quits in her 62nd year. The TFSA with a 3% growth rate after inflation would then have a $148,300 balance. On this basis, their disposable income would be about $7,670 a month, leaving about $2,600 a month for winter warmth someplace inexpensive. They are thinking that $2,500 a month for Costa Rica or Greece would cover their costs not including transportation. It would be life in an inexpensive apartment or modest rented home.
Harry and Priscilla do not want to rent their home to strangers while they are away for several months in winter. They have a summer cottage they could sell for its estimated $200,000 price less $25,000 for selling costs and tax on a non-principal residence. That would leave $175,000. That capital could earn 3% after inflation, or $5,250 a year. That would buy two months at the costs they estimate. They already budget $6,000 a year for travel. That would cover airfares to either place and some living costs away from home.