Situation: Concern about debt hangs over middle class couple’s retirement plan
Solution: Pay down the mortgage, ramp up RRSP contributions and invest the tax savings
A couple we’ll call Max, 53, and Loretta, 54, make their home in Alberta with children ages 18 and 20. Both kids are in university. The parents’ lives are a picture of middle-class normality. For now, their $9,995 monthly take-home income is adequate, but their outstanding mortgage of $262,606 has 19 years to run and they worry that interest rates might rise considerably. Max’s job in high tech is vulnerable, given the provincial economy. Loretta’s accounting job with a non-profit organization is also not guaranteed. They got a whiff of what could happen when Max’s former employer shut down, forcing him to settle for a new job with a 30 per cent salary cut. They did not see it coming, having bought their house three weeks before he got the axe.
Max and Loretta will be on their own when they retire in a dozen years. Their $815,500 house accounts for 70 per cent of their $1,155,973 in total assets. The balance is in conservative and diversified mutual funds that come with the usual fees. Max has not tracked the funds closely enough to determine if he is getting good performance for the amount he pays. The annual tab is a few thousand dollars that could go to something more useful if he swapped the balances into low-fee ETFs.
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Max sees his debt as a potential retirement obstacle. “Our mortgage is a burden. We would like to accelerate paying that down and, at the same time, fund our retirement accounts,” he explains. Family Finance asked Eliott Einarson, a financial planner in the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Max and Loretta.
That the couple’s $9,995 current take-home income should cover their $1,445 monthly mortgage payments easily and leave plenty of money for other things is not in question. It is the future that is problematic. They want to put the kids through a couple of more years of university even though there is only $3,438 left in their Registered Education Savings Plan. They estimate they will have to put $20,000 into tuition and related costs — the kids are too old to receive the annual Canada Education Savings Grant of as much as $500 per year. When the kids are done with school in three years, Max will be 56 and nine years from retirement at 65.
Max may get an annual bonus of $13,500 which would be $700 to $800 per month after tax. That provides wiggle room in addition to current unallocated savings of as much as $1,053 per month. That income flow can go to the kids for university expenses other than room and board, for they live at home. In three years, when the kids have finished university, this money can go to retirement savings, Einarson advises. The bonus is not a sure thing, so we are leaving it out of retirement-income calculations.
Max and Loretta can save a good deal of money when the kids are through with university. Those savings can be added to their present cash balance, $69,594. For now, if they reserve $34,000 for the remaining university expense, they will have $35,594 for mortgage paydown. The outstanding balance, $262,606 less this residual cash would leave a balance of about $227,000. To pay off that balance in the dozen years to Loretta’s age 65, assuming three per cent interest, would require monthly payments of $1,880. That’s $435 more than their present mortgage cost of $1,445 per month, but it would ensure that they go into retirement with no major debt. They could still add $480 to their RRSPs and $500 to TFSAs each month, as they do now, and boost these contributions with leftover cash.
In three years, when the kids are through with their first degrees, the parents can raise their monthly $480 contributions by $1,200 per month. That would mean putting $1,680 per month total into their RRSPs for the remaining nine years to their retirement. That would raise the current RRSP balance, $267,941 to $560,554 when Max is 65. That capital could generate $32,200 per year for 25 years to Max’s age 90.
Loretta has a group RRSP to which she adds $90 per month matched by the employer. At this pace, her RRSP, now $44,354, would grow with the $2,160 annual contributions to $89,060 when they are ready to retire and then support payouts for the next 24 years to her age 90 of $5,100 per year.
The RRSP savings would generate tax savings. They will vary with changes in gross income and any taxable events, but if we assume that Max is in a 40 per cent tax bracket, refunds from RRSP contributions could be $12,000 per year. That could go to paying down the three per cent mortgage, but Max and Loretta could likely earn a higher rate of return by investing the money in low-fee exchange traded funds.
Starting in three years when the education subsidy for their kids is finished, if Max and Loretta each put $6,000 per year into new TFSAs — they have none now — for nine years at 3 per cent per year after inflation, then when Max is 65, they would have combined balances of $125,566. That principal could support annuitized payouts of all income and principal of $7,000 per year for 25 years to his age 90.
Max and Loretta would have annual combined RRSP income of $37,300 and TFSA incomes totaling $7,000, two estimated Canada Pension Plan benefits totaling $20,465, and two Old Age Security benefits totaling $14,434 per year. All that adds up to $79,200 per year. There would be no tax on $7,000 TFSA income, so on the balance at 12 per cent average tax and with the TFSA payouts restored, they would have $5,878 per month to spend. With no mortgage or savings, a small trim to the restaurant and travel budgets, it works.
“They can maintain their way of life,” Einarson concludes.