Andrew Allentuck
Sept. 15, 2020
A couple we’ll call Mark and Sally, both 57, live in Ontario with their three children, two in their late teens, one age 21. Mark runs a small manufacturing company. Sally is a health-care professional. They take home $10,700 monthly.
Mark and Sally are concerned that income from their $313,351 of financial assets plus Sally’s future defined benefit pension, which kicks in at age 65, will be insufficient for them to maintain their present way of life in a retirement they hope to start in ten years at age 67. As things are organized now, they are right. They have no RESPs to help put their children through post-secondary education and are instead helping pay those costs as they go. Their savings are also inadequate.
Family Finance asked Derek Moran to work with Mark and Sally.
Financial services
The couple has a $337,416 30-year mortgage with a 2.74 per cent interest rate with 25 years to run until it is paid in full. They also have a $15,658 line of credit with annual interest of eight per cent. The mortgage costs them $1,350 per month and the LoC $320 per month. The line of credit interest is payable to a lender other than the mortgage lender. A borrower who is on time with payments can get a LoC added to the mortgage. Mark is paying almost three times the mortgage rate for what amounts to a small loan. It’s an easy fix. If their lender won’t do it, others would.
Charges for financial services are also a problem. Most of their financial assets in retirement accounts are in mutual funds. Many are segregated funds with a guarantee to pay back at least 75 per cent of original value if held for at least ten years. Most investment studies show that the odds of a market being down enough to trigger these guarantees after a decade are remote. Their best bet is to review their investments with a financial advisor and assess the cost of migrating to lower fee-funds.
Retirement planning
Mark and Sally want to have $6,250 per month in after-tax retirement income, but they need to be strategic in order to get there.
Using their RRSPs efficiently is one option. Mark has $226,341 of unused RRSP room and his marginal tax rate is 43.4 per cent, whereas Sally’s is only 29.75 per cent. Mark gets $137 more tax refund per thousand dollars of RRSP contribution than Sally. He can contribute to a spousal plan for Sally and capture the higher marginal tax savings, Moran advises.
Mark’s higher marginal rate is about 16 times their mortgage interest rate of 2.74 per cent — he can use his tax refunds to pay down the mortgage very efficiently.
Mark currently has $222,628 in his RRSP while Sally has $90,723 for a total of $313,351, and combined they are contributing about $20,500 per year.
If they continue to add that amount each year and it grows at three per cent after inflation for 10 years to their age 67, it will become $663,177. That sum, continuing to grow at three per cent after inflation, could pay out $34,312 per year for the following 28 years to their age 95.
Sally will have a defined benefit work pension that would pay her $12,720 beginning at age 67.
They will have two Canada Pension Plan benefits totalling $28,016 per year after postponing the start for two years. Their Old Age Security benefits, $7,362 per year boosted by a 7.2 per cent bonus for the two-year delay, will total $16,844 per year in 2020 dollars.
The sum of retirement income components with payments starting at age 67 for each partner would be $91,892. With splits of eligible income and pension credits, they would pay tax at an average rate of 15 per cent and have $6,500 per month. Their expense would decline by $1,080 in monthly savings, $700 in rent for their child in university, and perhaps another $1,000 can be trimmed from their food, utility and other bills. But they are still likely to have a shortfall.
Raising retirement income
The gap could be worked down, perhaps by cutting gifts to their kids or by selling their boat, which comes with a monthly maintenance cost of $600. It is a pleasure they would hate to lose. Their mortgage has a quarter century to go. They will be 82 when it is paid. Acceleration of payments would help, but there would still be a deficit between present expenses and expected future income.
One solution would be to wait an additional three years before retiring. Working until age 70 would lift RRSP savings and shorten the amount of time those savings would have to last. RRSPs would grow to $789,940 and then support payments of $45,364 per year for 25 years. CPP payments would grow at 8.4 per cent per year from 65 to 70 for three more years, net 42 per cent, to an age 70 total of $35,016. OAS benefits would grow at 7.2 per cent per year for three more years to $20,024 per year using 2020 rates.
Finally, Sally’s work pension would grow to $19,200 per year. The sum of all income sources would be $119,604. After splits of eligible income and average tax at a rate of 16 per cent, they would have $8,370 per month to spend. They would be over their $6,250 monthly target income with cash to spare. Extending retirement to age 70 would put their retirement on a more stable foundation.
