Situation: Professionals with pensions, rental income and modest financial assets focus on retirement
Solution: Pay off loans before interest rates rise, cut expenses to make target income more certain
In Toronto, a couple we’ll call Harry, who is 76, and Louisa, who is 63, are hanging on to their jobs. Harry, an engineer, is partially retired, Louisa, a financial manager, is still working full time. For now, they bring home $14,912 per month composed of $6,400 Louisa’s salary, $3,000 from Harry’s business, $2,400 from investments, and a total of $1,512 from Harry’s OAS and CPP plus rental income of $1,600 per month. They live in Ontario. They apply management skills to retirement planning. Their issue: do they have adequate resources for life ahead?
When retired, Louisa can expect $68,000 in company pensions and Old Age Security of about $6,860 for having been resident in Canada for 38 out of the 40 years required after age 18 to qualify for full benefits. Harry already receives OAS and CPP benefits.
By most standards, Harry and Louisa are prosperous, but they worry what will happen to their way of life when Louisa ceases to generate her $12,000 monthly salary. There is some uncertainty about when she should begin drawing CPP and OAS and when to start drawing down Registered Retired Savings Plan balances.
“We would like to spend about $10,000 per month after tax in retirement,” Louis explains. “We know that our pensions cannot support us, so we need a plan for using investments to supplement income.”
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Targeting retirement income
Family Finance asked Graeme Egan, head of CastleBay Wealth Management in Vancouver, to work with Harry and Louisa. In his view, the resources to generate $10,000 per month after tax are in place. It is a question of management to make the plan work, he says.
At the moment, the couple has about $2 million in assets, $1.5 million of which is real estate, $50,000 in cars and personal goods, and $455,000 in financial assets. They have modest debts of $78,000. That breaks down to $38,000 in a mortgage at 2.34 per cent and $40,000 in home equity lines of credit. Their net worth is $1,927,000.
Their plan is to retire in three years. At that time, Louisa’s company pensions will not be reduced. She will have two DB pensions — one $12,000 per year with no indexation and one $56,000 per year with indexation. The annual total of these pensions, $68,000 per year, implies a commuted value (capital required to generate the income) of about $1.5 million. She could cash in, but, Egan says, that could create a big tax liability. Professional management, indexation for most of the income, and spousal benefits suggest that it is wise to leave the pensions in place. She will have many survivor options, but she should stick with the present 60 per cent payable to Harry. Raising his benefit at the cost of lower benefits is illogical, for he is 13 years her senior, Egan notes.
Canada Pension Plan benefits work out to the $900 per month he currently receives and a projected $900 per month for Louisa. She should delay the start for a year to 66 and get an 8.4 per cent boost to $976 per month. After she quits her job, her tax rate will drop and the bonus for a year’s delay is worthwhile, Egan explains.
Adding up income components
At her age 66, Louisa will be able to receive employment pensions of $5,666 per month plus $976 CPP and $570 OAS. Harry is receiving $912 from CPP and $600 from OAS. All this adds up to $8,724 per month. On top of that, they would receive rental income of $1,600 per month to make total income $10,324 per month. Add Harry’s RRIF drawdown of $560 per month and they would have pre-tax monthly income of $10,884 — or $130,608 per year. Assuming that this income is fairly evenly split and pension and age credits applied, they would have annual individual incomes of $65,304. After 20 per cent average tax, they would have $8,700 to spend per month. That’s $1,300 below their $10,000 monthly after-tax income target.
It won’t be hard to boost income to the target level, Egan says. Their financial assets — excluding Harry’s $118,000 RRIF and assuming that $40,000 of Louisa’s non-RRSP investments is used to pay off her home-equity loans— of $297,000, at 3 per cent after inflation, would grow to $324,500 in three years. Adding back Harry’s $118,000 RRIF at her age 66 would provide a base of $442,500. Annuitized for 34 years to Louisa’s age 90, that capital would provide monthly income of $1,745. Some would be taxable, so that would leave about $1,300 net, Egan says. That would make their total after-tax monthly income $10,000, which is their target. Even if they spend all of this income and capital by Louisa’s age 90, they would still have a $1-million house appreciated at market rates, Louisa’s pensions, CPP, OAS and a rental property.
Adding income security
There is more that they can do to ensure that their retirement income is not eroded by inflation. Top of the list — pay off the $40,000 home equity loans. Half of that is at a floating rate of 4.2 per cent and half at 3.29 per cent. Interest rates are rising, so using some cash from non-registered investments makes sense. They can also cut expenses — $1,900 a month for food and dining out for two people is high; some trimming could save $500 per month. They are shelling out $1,000 per month to keep one car running. Trade it in, Egan suggests. They have a sailboat on which they spend $500 per month. If pressed, that could go. And there is $1,612 of cash savings as a cushion. It would grow if some expenses were cut.
There is little doubt that Harry and Louisa can attain the $10,000 monthly retirement income target and stay there by cutting debt service charges on home equity loans, paying off their rather small $38,000 mortgage that, in any event, will be gone in a year or so, and trimming present spending. When older, they may not want to sail, an activity that costs $6,000 per year. All in all, they are secure.
“Decades of preparation have made this couple comfortable now and in future,” Egan concludes. “They have ample reserves if they stay within budget.”