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Financial Facelift

Deal with debts, and retirement will be easy Add to ...

John and Marsha know that if they want to retire in eight years, they must start planning now. He is 52, she is 50.

Ten years will give them time to pay off the mortgage and other debts, build their savings and ensure their four children, aged 16, 18, 21 and 23, get a good start in life, perhaps by helping them with a down payment on a home. Three of the children are in university and the youngest will be going next fall.

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As a federal government employee, John has a defined benefit pension plan that would pay him $36,360 a year if he retired now but that will pay him nearly $50,000 a year, indexed to inflation, when he retires in eight years or so. That amount will fall by about $1,000 a month when John turns 65 and his pension is integrated with the Canada Pension Plan.

Marsha, who works as a teachers’ assistant, has a small defined contribution pension plan. Their children’s education is partly subsidized by the government of the Northwest Territories, where they live.

“Our rough plan is to pay off the mortgage – we will be downsizing in the next three to five years – and to be mortgage-free in five years,” John writes in an e-mail. He earns $113,000 a year, she makes $57,000. They have a home valued at $600,000 and a rental condo valued at $120,000 that their university-aged children rent for about $700 a month. “Are we on track?” John wonders.

We asked Alain Quennec, a financial planner and associate portfolio manager at Rogers Group Financial in Vancouver, to look at John and Marsha’s situation.

What the expert says

Marsha and John have a cash flow surplus of about $2,000 a month, so they should be able to achieve their retirement goals without too much trouble, Mr. Quennec says. With a little financial discipline, they could retire fully by the end of 2018 without having to downsize or reduce their discretionary spending.

As well, the big difference in their incomes both now and when they retire presents income splitting opportunities, the planner notes. John should definitely maximize contributions to a spousal RRSP for Marsha because he is in the higher tax bracket now, and will continue to be when they retire. Mr. Quennec recommends they both contribute the maximum allowed to their tax-free savings accounts.

If they keep making the same mortgage payment, they will be mortgage-free in nearly 11 years, he calculates. “If they put down an additional $1,000 monthly against the mortgage, it will be paid off in a little over seven years.” If they sold their home and bought a less expensive residence, as they plan, they could be mortgage-free even sooner. By paying $500 a month from now to the end of 2018, they would wipe out their line of credit as well.

In his forecast, Mr. Quennec assumes the couple sells the rental condo when they retire and that their equity in it at that point is $40,000, which they will fold into their investment portfolio. When their car is paid off in November, 2013, they can redirect the $670 monthly they are paying now to retirement savings as well. He assumes an inflation rate of 3 per cent and an average annual rate of return on their investments of 6 per cent.

Mr. Quennec suggests that John contribute $800 a month to a spousal RRSP for Marsha – to take advantage of income splitting – rather than making further contributions to his own RRSP. Marsha could also increase her contributions to her defined contribution pension plan by $200 a month. He assumes they both receive the maximum Canada Pension Plan and Old Age Security benefits, and that they live into their mid-90s.

On that basis, he figures they can generate about $67,000 a year after tax in current dollars, indexed to inflation, from 2019, their first year of retirement, through to 2054.

“That is less than they currently spend on all items, but they will also not have $35,000 in mortgage payments or line of credit payments, so that is effectively the comparable of $110,000,” the planner says. “They will also not make CPP or RRSP contributions, registered education savings plan payments, nor will they (hopefully) be supporting any of their children,” the planner points out.

“It will take a mild amount of discipline and little investment risk to achieve their goals, but it is very possible for them to retire without sacrificing any of their current discretionary spending,” he concludes.



CLIENT SITUATION



The people



John, 52, and Marsha, 50.



The problem



Paying off debts, saving more money and still having enough to help the children before they retire.



The plan



Raise mortgage and loan repayments substantially, focus on saving more for Marsha to take advantage of income splitting opportunities.



The payoff



A comfortable and secure retirement.



Assets



Mutual funds $22,000; John RRSP $45,000; TFSAs $9,000; RESP $51,000; stocks $10,000; spousal RRSP for Marsha $132,000; Marsha employer pension plan $25,000; present value of John's DB pension: $1,100,000; home $600,000; rental property $120,000. Total: $2,114,000



Monthly net income



$12,100 (includes $700 condo rent)



Monthly disbursements



Spousal RRSP $400; RESP $300; employer pension plan $200; dining out $360; groceries $800; clothing $50; house mortgage $2,890; condo mortgage $355; property taxes, condo fees $810; house, car insurance $235; utilities $540; telecom $250; maintenance $100; furniture, appliance replacement $100; travel $500; entertainment $100; auto loan $670; auto expenses $100; loan payment $50; life insurance $90; John's pension plan $1,100; gifts $100. Total $10,100. Savings capacity: $2,000.



Liabilities



Line of credit $30,000; investment loan $11,000; home mortgage $285,000; condo mortgage $92,000.



Total: $418,000



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