A couple we'll call Harold, 53, and Tanya, 45, make their home in a small town in B.C.'s Lower Mainland. On paper they are affluent, with assets of $1.3 million. But, if you remove the estimated value of their house they have just $454,450 in other assets for educating their seven-year-old daughter and, eventually, retiring when Harold is 65. They'd like after-tax income of $60,000 a year in retirement.
Harold is a mining industry management consultant who works on contracts. Tanya's job as a chemical engineer is more stable. The ups and downs of the mining business have left Harold foraging for work. Over the last few years, while working part time, Harold has brought home an average of $2,500 a month while Tanya has brought home $5,800 a month. With their combined incomes of $8,300 a month, they have made ends meet with little margin for unanticipated expenses or emergencies. For now, they are getting by.
“If my husband earns just a third or less of his potential $100,000 a year for the next dozen years to his planned retirement at 65, can we retire without selling our house and downsizing” Tanya asks. It is the central financial question of their future.
Family Finance asked Graeme Egan, president and portfolio manager with CastleBay Wealth Management Inc. in Vancouver, to work with the couple. “This couple has solid net worth,” he says. “They can achieve their retirement target, but it will take some adjusting of their portfolio.”
Their largest monthly expenditure is their $199,375 outstanding mortgage balance. They pay $2,350 a month and it will run for about 7½ years before it is paid off. They could add the $15,000 they have in cash to the mortgage, reducing the balance to about $184,000 and saving $3,700 in future interest and eight months of payments over the life of the mortgage, assuming interest rates do not change.
Alternatively, Harold and Tanya could raise mortgage payments by directing all of their RRSP and TFSA savings — $975 a month, or $11,700 a year — to the mortgage. That would bring total payments to as much as $39,900 a year. If their lender permits pre-payments of up to 20 per cent without penalty, the mortgage would be discharged in about five years, but they would be giving up all growth in their retirement savings. This would be an extreme choice for a single real estate asset and would deprive them of potential investment growth in diversified financial assets. Moreover, B.C. property prices could fall one day. They are better off to continue their savings.
At present, Harold and Tanya have $324,800 in their RRSPs and $46,850 in their TFSAs. If they continue to add $11,700 a year to the RRSPs and TFSAs for the 12 years to Harold's age 65 and generate three per cent a year after inflation, these accounts would have a balance of $695,930. That balance, if still growing at three per cent after inflation and paid on an annuity basis so that all income and principal were gone in the next 38 years to Tanya's age 95 would generate $30,940 a year.
At Harold's retirement — assuming Tanya retires at the same time but waits until she is 65 to receive government benefits — Harold's $11,800 Canada Pension Plan benefits and $6,846 from Old Age Security would add $18,646 to their annuitized savings for total, pre-tax income of $49,586. After splits of eligible pension income, 10 per cent average tax but no tax on TFSA payouts, they would have $3,720 a month to spend. At age 65, Tanya would add $13,110 in CPP benefits and $6,846 from OAS to push pre-tax income to $69,542. After 10 per cent average tax, they would have about $5,200 a month to spend. That's $200 more than monthly after-tax target.
Harold and Tanya can boost retirement income. At present, they put $575 a month into their RRSPs. It would make sense for all RRSP payments to be made by Tanya, since she has the higher income and can therefore get the most benefit from the tax deduction. She should direct as much as possible of the couple's $400 monthly TFSA contribution to her RRSP. Based on her gross income of $105,600, she can save as much as $19,000 a year, or $1,584 a month, in her RRSP. In her 40 per cent B.C. marginal tax bracket, that would save $7,800 a year in taxes, Egan notes.
Harold should use up as much TFSA space as he can until his income rises or he has filled his approximately $25,000 of remaining space which, at present rates, accrues at $5,500 a year.
Harold and Tanya have not taken an active interest in their investment portfolios. However, Tanya's employer provides a two per cent matching program and access to low-cost pooled investments. The allocation could safely be two-thirds stocks — half Canadian, and half U.S. and global — and one-third bonds. How these allocations will fare over a period of decades is speculative; however, the long-run returns for these asset classes is five per cent for stocks and two per cent for bonds, after inflation. Investment grade bonds with 10-year terms or less are relatively secure assets that mature at known values. Certainty has its rewards, Egan notes.
The final issue is what to do with their house. On an allocation basis, it forms 65 per cent of their assets, which is high but typical in the hot B.C. property market. They could sell it one day, perhaps when they retire, and add perhaps $200,000 to their investment assets. On a straight three per cent return basis, that would add $6,000 before tax to their cash flow, pushing them well above their desired $60,000 after-tax retirement income target.
The downside of planning a future sale of their house is the old saying that one should not count chickens before they hatch. In the dozen years before Harold's anticipated retirement at 65, property prices in B.C. could fall and the contracting B.C. mining industry, which forms a part of Harold's client base, could revive.
If the house is to be sold, then Harold and Tanya are likely to want to wait until their daughter is ready for post-secondary education in 10 years. She should have about $66,000 for post-secondary education if her $23,700 RESP continues to get $2,500 a year plus the $500 Canada Education Savings Grant and grows at three per cent a year after inflation. They are limited to $50,000 contributions per beneficiary and $7,200 in CESG additions. They will hit the CESG limit in another seven years if they maximize grants each year, Egan notes.
“The pinch that Harold and Tanya feel will disappear when their mortgage is paid off,” Egan says. “With present savings rates and modest growth, the couple is likely to meet their retirement target without stopping all investment savings just to eliminate the mortgage or having to sell their house. As long as they maintain savings, they can meet their goals.”