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In the the 15 years till Kal gets defined-benefit pension payments, he can bank $13,000 a year and spend $10,000 on vacations. (Tim Fraser For The Globe and Mail)
In the the 15 years till Kal gets defined-benefit pension payments, he can bank $13,000 a year and spend $10,000 on vacations. (Tim Fraser For The Globe and Mail)

FINANCIAL FACELIFT

Kal, 45, should ease up on RRSP contributions (at least for now) Add to ...

Kal is 45, single with no dependants and thinking about retiring at age 60.

As a police officer, he has a good income – and a defined-benefit pension plan. His lifestyle is comfortable but not lavish.

Kal has been putting all his extra cash – including money he gets from working overtime – into his registered retirement savings plan. He’s wondering whether this is the best strategy, or whether he should be directing it to a tax-free savings account or to his mortgage, which is his only debt.

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“I enjoy travelling out of country two or three times a year,” Kal writes in an e-mail. “I plan on buying a new car within two years and completing some home renovations,” he adds.

He recently got a raise, so he’d like to know how best to use the extra money.

“Should my priority be paying off the mortgage or contributing to retirement savings?”

We asked Charles Chan, a financial planner with E.E.S. Financial Services Ltd., in Markham, Ont., to look at Kal’s situation.

What the expert says

In the short term, Kal should shift his focus to savings that he can draw on easily to buy a car or repair his home, Mr. Chan says. As it is, he has no emergency fund. With his recent raise, Kal should be able to save about $13,000 a year after tax, not including any overtime, the planner estimates.

For now, “I would recommend using a TFSA before his RRSP or mortgage payments because he has extraordinary expenses coming up,” the planner says.

Another reason to delay RRSP contributions is because his income in future will be higher, putting him in the top marginal tax rate. “By delaying RRSP contributions until he is in a higher tax bracket, he gets a little bit more bang for the buck.”

Longer term, Kal should shift his focus back to his RRSP, followed in order of priority by a TFSA and then his mortgage. Even if mortgage rates rise to, say, 5 per cent in a couple of years, Kal will still be able to pay his mortgage off by age 60, Mr. Chan says.

The TFSA, meanwhile, “provides a tax-free stash for extraordinary expenses.” If Kal had to draw on his RRSPs to meet one-time expenses, he would have to pay tax on the withdrawals.

If Kal is not comfortable with the mortgage debt, he could contribute as much as possible to his RRSP and use the tax refund to pay down the mortgage. “He gets the best of both worlds this way.”

Once Kal has retired, he will get at least $43,700 a year from his work pension. He can also begin collecting reduced Canada Pension Plan benefits at age 60. The shortfall would have to come from his RRSP and other savings, Mr. Chan says. Kal’s goal is to maintain the same standard of living when he retires.

“As such, it is vital that he does not significantly increase his lifestyle [spending],” the planner says. “To the extent possible, he should live the same lifestyle he had before his last salary increase and save the surplus, as well as any money he makes working overtime.”

At age 67, Kal can begin drawing Old Age Security benefits.

If all the assumptions hold, Kal’s savings will allow him to sustain his current lifestyle spending until he is 85, Mr. Chan says. While he would have to cut back then, he would still have his pension income and government benefits, as well as his home.

In preparing his forecast, Mr. Chan assumed that: Kal remains single; his salary and expenses both increase by 3 per cent a year; he will earn an average annual return on his investments of 5 per cent; he will spend $10,000 a year on travelling; and that he will set aside $5,000 a year for car replacement starting at age 55.

He also factors in the $10,000 in renovations Kal plans to do on his home and the $30,000 car he plans to buy in a couple of years.

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Client situation

The person

Kal, 45

The problem

Setting priorities for his surplus cash flow.

The plan

Start by saving money in a tax-free savings account for big items such as house repair and car replacement, then shift to the RRSP, using tax refunds to pay down mortgage.

The payoff

The likelihood of achieving all his goals, including retirement at age 60 with a comfortable income and enough money to travel.

Monthly net income

$7,100

Assets

Cash $2,000; shares $600; RRSP $220,000; house $385,000 Total: $607,600 (estimated present value of defined-benefit pension plan not available).

Monthly disbursements

Mortgage $1,055; utilities, maintenance $640; transportation $420; food, clothing $585; gifts, charitable $245; vacation, travel $835; dining out, entertainment $535; clubs, sports, hobbies $70; subscriptions $80; telecom, TV $245; RRSP $500; pension contributions $835; professional association $100. Total: $6,145

Liabilities

Mortgage $133,000

Want a free financial facelift? E-mail finfacelift@gmail.com

Some details may be changed to protect the privacy of the persons profiled.

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