Retirement Means a Big Move To a Smaller House
Situation: With a taste for good living, a woman has failed to save enough for retirement
Strategy: Work six more years, downsize house, trim spending
Solution: A sustainable retirement after cuts in spending
Madeleine, as we’ll call her, is 64 and pondering retirement. Her income from her Vancouver-based management consulting business, about $100,000 a year, plus Canada Pension Plan benefits for which she applied early, $9,120 a year, leaves her with monthly after-tax income of as much as $6,400 on average.
Life has treated Madeleine well. Her B.C. house, for which she paid $935,000 nine years ago, has appreciated to $1.8-million and she has a total of $620,000 in RRSPs and her TFSA. Her assets total about $2.4-million and her two children, both in their 30s, have successful lives of their own. One would think Madeleine has no problems, yet she is spending 50% more each month than her take home income.
The money she spends is personal – lots for personal therapies, travel and gifts to her grown children. She drives a 15-year old car she can’t afford to replace and worries that her spending will drive her into poverty when she retires. Her choices are to cut spending, work more years or sell her house. Or some of all three.
“My spending is out of control,” she acknowledges. “I have a line of credit on which I barely make interest payments. My biggest fear is to end up in an assisted living establishment in one room where my kids and grandkids have to support me.”
In fact, Madeleine is up against not only her heavy spending, but the fact that she is supporting her way of life on one income. Much of the spending is social expense, such as her $715 per month for food and dining out for one person. She spends another $888 for medical therapies the province won’t cover. With one income, even a sound one like hers, she is unable to cover her $100,000 line of credit, which is, in effect, an extension of her purse.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Madeleine. “On the surface, she is healthy, successful and happy. But when we look at her assets, 73% of which are in her house and producing no income, another picture emerges,” he explains. “She has no mortgage, but her house operating costs including $7,500 a year for property taxes, $4,500 for maintenance, $1,368 for gardeners, $1,380 for cleaning, plus $3,900 for insurance and utilities, a total of $18,648 a year, eat up a quarter of her after-tax income.
She can pretend to afford the house now, but in retirement it will be impossible to sustain it and the rest of her way of life
Moreover, the money tied up in the house produces no income. At $1.8-million, it is a large sum, but it’s not unusual in British Columbia to find people with average incomes living in houses priced for people who, in other places, would be considered downright rich. She can pretend to afford the house now, but in retirement it will be impossible to sustain it and the rest of her way of life.” Then it will be the reality of living an above average life on just one income.
Overspending and Undersaving
Madeleine is right to worry about her financial future, for she is spending herself into serious debt. Her $100,000 line of credit is for personal expenses. The interest expense, which she is paying in full, is not tax-deductible. Worst of all, her seemingly substantial RRSP, $605,000, is not sufficient to sustain her approximately $100,000 a year of spending net of RRSP savings for more than half a dozen years. And when she gives up her business, which pays some of her personal costs and allows for advantageous tax deductions, the shortfall will get worse.
When retired and no longer in business, with present assets, Madeleine will have her present CPP benefit of $9,120 a year, Old Age Security benefits of $6,553 a year, both at 2013 rates, $18,150 pre-tax income at 3% per year after inflation from her $605,000 of RRSP assets and $450 a year with no tax from her present $15,000 of TFSA assets. The total, $34,273 a year, almost all taxable, will not sustain her way of life.
A Retirement Plan
This would stretch her savings, which are still growing with $15,000 annual RRSP contributions. Growing at 3% a year before being distributed, the RRSP would rise to about $822,350 in six years when Madeleine is 70. It would sustain a 7% withdrawal from age 71 rising over time according to government regulations. However, her overspending would continue to accumulate as debt on her line of credit.
Madeleine is right to worry about her financial future, for she is spending herself into serious debt.
Over the 20 years to her age 91, the RRSP would pay out all of its earnings and capital. That would produce $55,078 a year before tax, Mr. Moran estimates. On top of $15,673 in combined Old Age Security and her estimated CPP at 2013 rates, she would have pre-tax annual income of $70,751. After paying income tax at a 20% average rate rate, she would have $56,600 a year or $4,717 a month to spend. Her untaxed TFSA generating $450 a year after inflation with no tax would push her monthly after-tax income to $4,755 a month. That would still be far short of present spending net of savings.
Madeleine has no choice but to sell her house and downsize. There will not be capital gains tax, for it is her principal residence. If she were to net $1.7-million after selling expenses, she could pay off the $100,000 line of credit and keep $400,000 for a condo well away from central Vancouver where she would be priced out of the market. It would not have to be the boondocks, just not in the priciest part of the B.C. market.
The remainder of funds from sale of the house, $1.2-million, invested to produce 4.5% in large cap companies with a good history of dividend payments and prospects for raising them, would generate $54,000 a year before tax. Added to her $70,751 of RRSP and government pension income, she would have $124,751 before the OAS clawback, which currently begins at $70,954 and takes all OAS at $114,640 annual gross income.
Madeleine would be left with about $118,200 a year. After paying 30% average income tax on this sum, she would have approximately $6,900 a month to spend. Without the $1,114 per month she currently pays for property tax, home maintenance, gardening, house insurance, etc., $1,250 monthly RRSP contributions, and with some trimming of her $600 a month for entertainment, and better accounting and perhaps rationalization of her unaccounted miscellaneous expenses, she could be cash flow positive.
“Madeleine’s spending and allocations are not sustainable,” Mr. Moran says. “Sooner or later, she must downsize her house and cut back on her perks. She could also extend her working life six or more years. She might also do a combination of these things. Her best asset is her house. If she can turn part of its value into an income stream, she will have a comfortable retirement.”
(C) 2013 The Financial Post, Used by Permission