Situation: With limited RRSPs and no TFSAs, couple worries retirement income will be too low
Solution: Delaying RRSP payouts can help make retirement at 60 a reality
In Ontario, a couple we’ll call Nick, 52, and Helen, 47, are raising their daughter, Louisa, 10. They have a good life with an income of $10,400 per month after tax. Helen, who works for a large communications company, is in a defined benefit pension plan. Nick is a self-employed contractor. They have $56,150 in GICs and cash in the bank, $390,000 in their RRSPs and $11,156 in Louisa’s RESP.
Nick and Helen have $1.12 million of real estate including their $550,000 house. Their mortgages eat up $3,400 of their $10,400 monthly income. The properties are nominally profitable. One rental, with a $10,004 net annual income before tax, returns 5.4 per cent on its $184,000 equity. The other rental, with $2,412 net annual income, returns just 2 per cent on their $136,000 equity. Real estate adds up to 63 per cent of their $1,766,306 total assets. That’s a substantial allocation to one asset class. No market is immune to downturns.
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“We want to accelerate payment on the mortgages for our house and the two rental properties,” Nick says. “Should we take the opposite path and just sell the rentals?”
Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Ltd. in Montreal, to work with Nick and Helen.
Education savings come first. By the time Nick and Helen are ready to retire, Louisa will be ready for post-secondary studies. Her Registered Education Savings Plan, which has a present balance of $11,156, growing at $2,500 per year plus the Canada Education Savings Grant of $500 up to a $7,200 limit per beneficiary — which won’t be reached — should have a balance of $40,800. That will pay for four years of books and tuition at most post-secondary institutions in Ontario. If there is a gap, Louisa can get summer jobs.
Helen will have a defined benefit pension that, with present data, will pay her $24,000 at 65 and a $10,000 bridge for as much as 10 years if she takes early retirement. That bridge ends at 65. But their retirement income will soar after the rental mortgages are paid.
Each has $63,500 of space in their tax-free savings accounts. As the mortgages are paid, their cash flow will rise and they can contribute to TFSAs. Nick has $25,000 in his company’s bank account. However, because the company is not incorporated, it is his after-tax money. He should keep the money liquid in case they need emergency funds for spending or perhaps for servicing the rentals, Nalbantoglu suggests.
In retirement, the rental mortgages, which cost Nick and Helen $2,000 per month, will be paid in full as will their home mortgage, which costs $1,400 per month. RRSP contributions, $1,100 per month for Nick and $250 per month for Helen, will be history. Their present RESP cost, $250 per month, will have ended. Their monthly expenses, which are now $10,277, will drop to $5,277. That will be well within their expected after-tax incomes and that will happen without accelerating mortgage payments.
RRSP savings will boost retirement income. Nick adds $1,100 per month to his RRSP with a current balance of $270,000. In eight years, when he expects to retire at age 60, the account should have a balance of $459,400. If that sum continues to grow at 3 per cent per year after inflation, then in 11 years, when he converts this account to a RRIF, it will have a balance of $635,930. Annuitized to pay out all capital and income for the following 29 years to Helen’s age 95, it would generate $33,140 per year.
Helen contributes $250 per month to her RRSP. In eight years, assuming that she retires at the same time as Nick and with the same assumptions, her RRSP, with a $120,000 present balance would have appreciated to $178,700 in the following 15 years to her age 71, the account, with no further contributions but the same growth rate, will have grown to a value of $286,700 and support payouts of $16,430 per year to her age 95.
Their rental properties will be generating the current amount, $12,416 per year in taxable income. That income will grow to $36,416 when the mortgages, which now cost $24,000 per year, are paid off at about the time Nick and Helen retire in eight years at his age 60. Patience will pay.
Nick can apply for Canada Pension Plan benefits at age 60. If he receives an estimated $8,221 per year, as he expects, then, with rental income of $12,456 and Helen’s $34,000 job pension plus bridge, their pre-tax income would be $54,772 per year. Assuming that they split eligible income, they would pay tax at an average rate of about 11 per cent and have about $4,100 per month to spend. They would be able to cover any shortfall out of the cash reserve.
When the rental mortgages are paid off in full in nine years, the couple’s rental income will rise to $36,456. They can add Helen’s $34,000 job pension for nine more years until she is 65. That’s $70,456 per year.
In 13 years, Helen could take early CPP benefits at age 60 of $8,191 per year. Nick would be receiving OAS at $7,217 per year at 2019 rates. Their total income before Helen is 65 would be about $85,900 per year. After splits of eligible income and tax at an average rate of 14 per cent, they would have about $6,150 monthly to spend.
At age 65, Helen’s pension will lose its $10,000 annual bridge and shrink to $24,000. Her CPP pension can start at $12,984 per year. Her $7,217 Old Age Security will start. Nick will be 71. By the time she retires in seven years at her age 54, her RRSP, converted to a RRIF at age 71, will pay $16,430 per year. On top of Nick’s $33,140 annual RRIF income, they would have $145,600 income before tax, Nalbantoglu estimates. After 20 per cent average tax, they would have $9,700 per month to spend.
“Helen’s pension income cuts their financial risk of having too much of their wealth in real estate,” Nalbantoglu explains. “Their income will almost certainly rise in stages in retirement.”
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