Brett and Lila have been living fairly modestly and using all their surplus cash to pay down the mortgage on their B.C. home as quickly as possible. Now that they’re in their 40s, they wonder whether they should rethink their strategy and “shift to saving more for retirement,” Lila writes in an e-mail. They’ve been married for only six years.
“We have just amalgamated our separate real estate into a new townhouse and are starting to look ahead to retirement,” Lila wrote. “We don’t have a lot and will be depending greatly on our pensions.” Both have government defined-benefit pension plans, indexed to inflation.
Brett earns $66,700 a year, Lila $93,000. Their goal is to retire at the age of 60, the first year they will be entitled to unreduced pensions. They are not sure how much they will need to live on, but they want to maintain their current standard of living and travel a bit more.
They wonder if they are on track. Which is a better retirement savings vehicle for them, their registered retirement savings plans or their tax-free savings accounts?
We asked Jason Pereira, a financial planner at Woodgate & IPC Securities Corp. of Toronto, to look at Brett and Lila’s situation.
What the expert says
Brett is expecting a promotion in a few years that would substantially raise his salary, Mr. Pereira said. He has incorporated this higher number into his forecast.
The couple’s lifestyle expenses, excluding mortgage and car payments, are about $56,000 a year. Their travel budget is $5,000 a year now, a number that will rise to $15,000 a year after they retire from work.
In drawing up his forecast, Mr. Pereira assumes Brett and Lila retire as planned at age 60. Brett begins drawing a pension of $27,720 a year. Lila’s pension is $43,030 a year.
“Their retirement spending will be primarily taken care of through their work pensions and government benefits,” the planner noted.
Because of this, they should continue to focus on debt reduction in the meantime, he said. He recommends they continue to use all free cash flow to pay down the mortgage. “When the mortgage comes due for renewal in 2022, they should cash out their TFSAs and pay it off,” he said.
Their next priority should be establishing an emergency fund. Mr. Pereira suggests $43,000. The money could be held in a liquid investment such as a savings account or short-term bond fund, which may pay a slightly higher interest rate.
As their savings grow, Brett and Lila should look at consolidating their various accounts in order to ensure their asset allocation is appropriate, Mr. Pereira said. Right now, they have “a random assortment of exchange-traded funds, mutual funds and stocks with no unified portfolio strategy.” He recommends an income-generating portfolio of 40-per-cent bonds and 60-per-cent stocks, with the balance shifting in favour of fixed income after they retire from work.
“Given their relatively low marginal tax rates, no further contributions should be made to their RRSPs,” the planner says. They don’t want to find themselves paying more in tax later, when they have to make mandatory minimum withdrawals from their registered retirement income funds, than they are saving now.
With the emergency fund in place, Brett and Lila should turn their attention to maxing out their TFSAs. When that contribution room is all used up, they can open taxable investment accounts and begin saving there.
As for their retirement income, the planner assumes Lila and Brett start drawing Canada Pension Plan benefits at the age of 60. They get Old Age Security benefits at the age of 65. At age 71, they convert their RRSPs to RRIFs and begin making mandatory withdrawals the year they turn 72.
Mr. Pereira’s forecast assumes a rate of return on investments of 6.4 per cent while Brett and Lila are still working and 5.6 per cent after they retire. That’s in line with historical averages, he notes, but they could earn less and still be able to achieve their retirement goals.
“They do not need to take on market risk.”
As their wealth grows, Lila and Brett should contemplate how they plan to distribute their estate, the planner said. They have no children. If leaving a big estate is not a priority, they could increase their retirement spending target – possibly substantially, depending on their investment returns – and still have enough savings to last to the age of 95.
The people: Brett, 48, and Lila, 46
The problem: Should they pay off their mortgage aggressively or save more for retirement? Which vehicle is more suitable, RRSPs or TFSAs?
The plan: Pay off mortgage first, then establish emergency fund. Consider consolidating investment accounts. Save first in TFSAs then in taxable investment accounts.
The payoff: Financial freedom without having to take big risks.
Monthly net income: $10,860
Assets: Cash $7,000; his TFSA $35,800; her TFSA $38,985; his RRSP $74,230; her RRSP $113,775; estimated present value of his pension plan $112,700; estimated value of her pension plan $169,500; residence $650,000. Total: $1.2-million
Monthly disbursements: Mortgage $1,770; condo fee $235; property tax $155; home insurance $40; heat, hydro $70; transportation $380; groceries $600; clothing $100; car loan $610; gifts, charity $90; vacation, travel $415; other discretionary $700; dining, drinks, entertainment $420; personal care $50; sports, hobbies $200; pets $50; subscriptions $60; drugstore $70; cellphones $110; TV, internet $120; RRSPs $400; TFSAs $400; pension plan contributions $1,135; professional association $105. Total: $8,285 Surplus: $2,575 goes to mortgage.
Liabilities: Mortgage $262,105; car loan $20,000. Total $282,105
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