Recently separated, Eileen is starting a new chapter in a new home in a small Ontario town. She is 58 with three grown children.
Eileen says her two-bedroom bungalow is perfect for her later years so she wants to stay there as long as possible. Because she has no pension plan, though, she wonders how she will get by financially when she eventually retires from work.
Eileen, who is self-employed, has a few good contracts that bring in about $56,500 a year. While this is enough to live on, it is not enough to pay off her mortgage and line of credit, which total $110,000, any time soon. So she is hoping to win some new business.
The goal is to “set up my new life so I can manage financially,” Eileen writes. “It will be tight and a little scary, but I am excited about the change and hoping to make it,” she writes. Short-term, she hopes to have enough discretionary income to enjoy local outdoor activities such as cycling and skiing.
She wonders how much longer she will have to keep working and when she should start collecting government benefits. She is thinking about withdrawing money from her registered retirement savings plan to pay down her debts. Her retirement spending goal is $36,000 a year after tax.
We asked Stephanie Douglas, partner and portfolio manager at Harris Douglas Asset Management in Toronto, to look at Eileen’s situation.
What the expert says
First, Ms. Douglas looks at how long Eileen’s savings would last if she retired at 65 and spent $36,000 a year, adjusted for inflation.
If Eileen retires at 65, she would get about $22,000 a year from Canada Pension Plan and Old Age Security benefits, the planner says. The balance of her cash needs would come from her investable assets, which by the time she is 65 in seven years would total $526,000, mainly in her RRSP and locked-in retirement accounts.
“She would have a cash-flow deficit starting in 2046 when she is 85 years old,” Ms. Douglas says. This is based on an assumed 4.5-per-cent rate of return on her investments. “At this point, she would need to sell her property, which would be worth roughly $940,000 (increasing at the rate of inflation).” If she sold her house at 85 and rented for $2,000 a month in current dollars, she would still have investments of roughly $750,000 at 90, the planner says.
Eileen can take steps to avoid having to sell her bungalow. “She would need to increase her income and pay down her debt, work longer or lower her retirement spending goal,” Ms. Douglas says. As it is, based on her current loan payments, Eileen wouldn’t have her debt paid off until her late 80s.
If Eileen could drum up some more business, bringing in an additional $20,000 a year, she could raise her loan payments to $1,500 a month and have the mortgage and line of credit paid in full by 65. That compares with $550 a month she is paying now. She’d have enough savings and investments to fund her retirement without having to sell her house. At 90, she’d have investments of about $190,000 and a house worth about $1-million.
In the meantime, Eileen should focus on paying off the line of credit first because it has the higher interest rate, the planner says.
Another alternative would be for Eileen to keep working to 67, or even longer if part time, Ms. Douglas says. Or she could cut her retirement spending goal to $34,000 a year.
Next, the planner looks at Eileen’s savings and investments.
Tapping into her RRSP to pay down debt isn’t advisable, Ms. Douglas says. If Eileen cashes in the $75,000 guaranteed investment certificate in her RRSP, it would push her income to $130,000 or more, resulting in a significant tax bill. “She would be better off waiting until she retires to make RRSP withdrawals when she is in a lower tax bracket.”
For an emergency fund, Eileen should keep three to six months of expenses in cash (roughly $10,000 to $20,000) or be prepared to borrow against her line of credit. As well, Ms. Douglas suggests Eileen keep five to seven years of required withdrawals in fixed-income securities once she retires so that she is not forced to sell stocks during a weak market. This would be roughly $160,000 to $230,000 after accounting for inflation, giving her a minimum of 30-per-cent fixed-income exposure in her portfolio. Depending on her risk tolerance, her fixed-income allocation could be higher, the planner says.
Eileen’s current asset allocation across all her accounts is 75-per-cent equities, 5-per-cent fixed income and 20-per-cent cash. The accounts, now spread across three different financial institutions, would be better kept all in one place to make it easier to keep track of her performance and asset allocation, Ms. Douglas advises.
If Eileen decides to work past 65, she should delay taking Canada Pension Plan and Old Age Security benefits to get the higher payment, the planner says. Both can be delayed to the age of 70. CPP payments increase by 8.4 per cent every year to the age of 70, and OAS payments by 7.2 per cent. “These payments are protected against inflation for life.”
Finally, Eileen updated her will and power of attorney after her separation, but she should also ensure she has elected a beneficiary for her registered accounts to ensure those funds pass through probate and go directly to the intended person, Ms. Douglas says.
The person: Eileen, 58
The problem: How long can she keep her house if she retires at 65 with $36,000 after tax?
The plan: Look for ways to bring in more income to pay down her debt before retirement, work longer or lower her retirement spending target.
The payoff: A better understanding of the trade-offs needed to achieve her goals.
Monthly net income: $3,800
Assets: House $550,000; stocks $2,450; RRSP $244,920; LIRA $120,995; TFSA $12,000. Total: $930,365
Monthly distributions: Mortgage $250; property tax $300; home insurance $40; utilities $245; maintenance $300; transportation $470; groceries $400; clothing $150; line of credit $300; vacation $100; entertainment, dining out, alcohol, hobbies, personal care $400; pet expenses $50; health care $50; life insurance $155; phones, internet, cable $215; RRSP and TFSA contributions $150. Total: $3,575
Liabilities: Mortgage $50,000; line of credit $60,000. Total: $110,000
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