Brook and Pat are accomplished professionals in Alberta who have combined their fortunes. A senior executive, Brook is 57 and earns $246,500 a year. Pat, an engineer, is 55 and has a $123,000 annual income.
It would seem a life of achievement with ample rewards. But the clock is ticking on their careers. Brook is planning a retirement within three years. The plan - open a consulting business.
Pat, two years younger, is likely to retire at the same time. Their current lifestyles will be impossible to maintain on their retirement incomes. Brook and Pat know this, but they are not sure of what those incomes will be. Much of their asset base is in U.S. pensions.
"We want to retire, but do not know if our retirement accounts and investments will really allow that," Brook explains. "We would like to travel a great deal and hope to maintain a simpler, less expensive lifestyle that would allow for a comfortable existence."
What our expert says:
Facelift asked Derek Moran, who heads Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Brook and Pat in order to assess their pensions and other retirement income. They have substantial assets which, consisting largely of U.S. pensions, are hard to value with precision. But they have a debt problem as well, for they owe $794,000 on their house mortgage financed at 5 per cent. None of the $4,013 monthly payment on the house mortgage is deductible from income, Mr. Moran notes.
"They have to decide where they will live. Will that be in their present house or will they build a house on land they own in the Maritimes? They are three years from retirement and, in spite of a high rate of saving, they won't be able to pay off the house before they quit work. They must reduce their massive debt. It is simply unsustainable."
They cannot pay off the debt with their assets, most of which are tied up in pensions, but they can continue to finance their debts out of their combined present income of $20,800 a month. Problems will arise after retirement when their incomes drop to $10,262 a month. That would work out to perhaps $7,500 a month after tax.
That is less than their current monthly expenses of $11,400, net, of their monthly savings. However, if the mortgage debt were removed, their expenses would drop to a more manageable level of $7,387.
That would be within their budget, Mr. Moran says.
The sale of their house, currently valued at $1.6-million, would leave them with about $800,000, depending on market conditions and their transaction costs. Alternatively, they could sell their $315,000 parcel of land in the east. They could also add $75,000 of cash held in various bank accounts. Even this reduction of about half in their mortgage debt would give them breathing room when they retire, Mr. Moran notes.
If they fail to reduce their exposure to debt, they will face the possibility of having to pay much higher debt charges, should interest rates rise. If both properties were sold and debts were paid, then they would still have about $1.1-million to spend on a house. That kind of money should buy a good property in any Alberta city, he adds.
Brook and Pat have eight U.S. pensions that will produce retirement income. They have substantial entitlements to U.S. Social Security and small entitlements in the Canada Pension Plan.
They also have fractional entitlements to Old Age Security. Adding up their complex web of pensions, they will have monthly payments of $7,383 from various plans including $4,923 from a U.S. state plan, $1,946 from U.S. Social Security, $89 each from the CPP, and a combined $336 from OAS, likely to be subject to the clawback, which currently begins at $63,511 of gross income including U.S. Social Security benefits.
On top of those sums, they will have an estimated $2,879 in investment income. U.S. and Canadian dollars have been trading near par, so no currency adjustments have been made. Total monthly income from these sources adds up to $10,262 before tax. That is a substantial monthly retirement income for any couple, but it is only about half of their current monthly incomes, Mr. Moran notes.
The following analysis is based in part on a review by Katri Ulmonen, a chartered accountant who specializes in cross-border tax issues for accounting firm Mackay LLP in Vancouver.When Brook and Pat begin to tap their U.S. pensions, there will be a 15-per-cent withholding tax imposed by the Internal Revenue Service on regular monthly withdrawals, which will be claimable as a foreign tax credit on their Canadian income tax returns, Ms. Ulmonen notes.
U.S. Social Security benefits will be taxable in Canada on only 85 per cent of amounts paid, she adds. Curiously, if they sell their Alberta house, only $250,000 of any capital gain will be shielded from U.S. income tax. The remainder will be subject to a low capital gains tax rate of 15 per cent, but that tax will not be claimable against Canadian income tax, she adds.
Pat has a U.S. Roth Individual Retirement Account with $65,000 of assets.
Roth IRAs provide no tax deduction for contributions, but they do allow assets to grow without taxation prior to distribution.
Money withdrawn will be subject to tax, but the U.S. system allows early withdrawals to be taken from capital. Interest accumulates within the plans and remains immune from tax until paid out, Ms. Ulmonen explains.
Brook and Pat are on track for a six-figure pretax annual retirement income, half from Brook's U.S. state pension and the remainder from their other pensions. That's a good deal, but much of their pension base is not indexed, so the purchasing power of their funds will fall over time, Mr. Moran says.
With no children and no wish to leave a large estate, they could tap into their home equity at some point, using the capital gains on whichever property - Alberta or the Maritimes - they elect to retain. To be conservative, they may wish to leave the equity until later in life, the planner suggests.
"This plan is about a couple used to a high quality of life and their means to maintain it in retirement," Mr. Moran says. "If they pick a single residence that they like and get it paid for, they are on track for a comfortable retirement. The bottom line, however, is that in retirement, they cannot have it all."
"It is reassuring to have figures that show us what we will have for a base income when we retire," Brook says. "It outlines what we have to do to retire our debt. And it tells us what we will have for a basic income if either of us do part-time or consulting work when we retire."
Well-paid Alberta couple worried about the cost of retirement.
Adapting lifestyle to reduced future income.
Sell real estate and reduce debt to avoid an interest rate squeeze.
Abundant income for a more secure way of life.
Net Monthly Income
House $1.6-million, land in Maritimes $315,000, company pension $54,500, Roth IRA $65,000, Pat's annuity $80,000, Pat's RRSP $64,000, standard IRA $387,000, Pat's U.S. company pension $31,000, Brook's employer pension $18,000, cash $75,000. Total: $2,689,500.
Mortgage $4,013, auto lease $665, property taxes $639, food $500, dining out $500, clothing $1,250, RRSP contributions $1,583, car gas $120, house & car insurance $250, travel $750, gifts & charity $200, miscellaneous $1,000, savings $9,330. Total: $20,800.
House mortgage $794,000.
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