A couple we’ll call Howard, 49, and his wife Cecily, 50, have worked together for a quarter-century as executives of a religiously affiliated social-service organization in Alberta. Committed to helping others, they contribute about 10% of their after-tax income to charity. They have built up just 40,000 in RRSPs and have no money in TFSAs. Just to buy their present house, they had to borrow $20,000 from their children’s part-time job earnings.
But their combined after-tax incomes, $9,431 a month, support a comfortable way of life. And two defined-benefit pensions will take the sting out of their lack of saving.
Their two children in their early 20s are thriving in their studies. One lives independently and is completely self-supporting with research grants while doing a graduate degree. The other, partially self-supporting with jobs, is doing an undergraduate degree and lives at home.
Howard and Cecily have chosen to be modest in their way of life. Their commitment to giving in the form of their $900 monthly charitable contributions, 2.6 times their monthly savings, has made paying off $253,356 in debts before their planned retirement in 15 years a challenge. Eventually, they figure, they will downsize to a smaller house and liberate equity for retirement expenses.
“When we retire, probably when we are in our mid-60s, our incomes will be reduced from our current level,” Cecily explains. “In the meantime, we have a kitchen to renovate.” Their renovations, mainly their kitchen, would cost $65,000, they estimate, about 11% of the present estimated $634,000 value of the house.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Howard and Cecily.
Their mortgage, currently $235,356 with a 3.05% interest rate, costs them $1,600 a month. They can accelerate debt reduction when in less than a year the $1,000 a month they spend on their car loan and another $1,000 a month they use to repay a loan from their children will be freed up.
If they add that $2,000 to their monthly mortgage payments for a total of $3,600 a month, their amortization would be reduced from 15 years remaining to 6.6 years. That would save them total interest of $31,980, Mr. Moran estimates. With the increased payment, and adding $65,000 to loan principal for the renovation, the amortization would be increased by about two years. We can assume the renovations raise the value of their house dollar for dollar to $699,000. If they keep the house and if house prices increase by 2% a year in real, inflation-adjusted dollars, then, on the eve of their retirement in 15 years, the house would have a market value of about $940,000.
Swapping their present home for something smaller, they might capture $300,000 of equity. Those funds, invested to generate 3% a year after inflation, would produce income of $9,000 a year. That would supplement their modest RRSPs and add to what will be substantial and, in their view, adequate defined-benefit pensions from their employer.
At retirement, the couple will have total employer pensions of $64,140 a year. At age 65, each will receive Canada Pension Plan benefits at the maximum level of $11,840 a year and full Old Age Security of $6,481 a year. Add $1,872 estimated income from $40,000 of registered investments growing at 3% after inflation a year that will become $62,400 in 15 years with no further contributions, and $9,000 annual income from money liberated via house-size reduction, and their total pre-tax retirement income would begin at $111,654. If their pension income is evenly split, each would have pre-tax income of $55,827, well below the start point of the OAS clawback, currently $69,562. After tax at a 20% average rate, the couple would have $89,323 a year to spend in 2012 dollars. That would be almost 80% of their pre-retirement disposable income.
Their income is at risk when the first spouse dies. One person’s CPP and OAS benefits would stop, cutting the survivor’s income to $93,333. That would expose it to the clawback. Using the current clawback start point, he or she would lose $3,566 of OAS benefits.
Even with a reduction of after-tax income, the survivor would probably be able to maintain his or her way of life. The risk to that way of life lies in inflation, for the greatest part of their future retirement income would be their non-indexed employment pensions. They can hedge their inflation risk by working to age 65 or even longer and deferring taking CPP benefits. CPP benefits under new legislation increase by 0.7% a month for each month after age 65 at which they begin. That’s 42% for five years. If they worked to age 70, the boost for two CPP pensions would be $9,946, or about 9% of their total age 65 estimated retirement income.
Howard and Cecily can do more to increase their financial security in retirement in two ways — one, with any available cash, add to RRSPs and open TFSAs, and two, make their present RRSP investments more efficient. The investments in four well-known mutual funds are reasonable for their historic performance, but their fees are as much as 2.78% of net asset value a year. In 15 years to retirement, those fees will add up to 41.7% of present asset value. The connection of fees with performance is tenuous. The conservative course is to cut fees by switching to exchange-traded funds, the riskier course is to stay with their well-regarded fund managers and hope the force remains with them for the next decade and a half. “Working in retirement to boost income would not necessarily be a burden for the couple,” Mr. Moran says. “Staying on the sidelines is probably not going to happen. In their case, what one might call a participatory retirement is most likely their future."
(C) The Financial Post, Used by Permission