Dale and Daphne are fiftyish professionals with a nine-year-old daughter, good jobs and a semi-detached house in the Greater Toronto Area.
Like many folks their age, they are wondering how much money they will need when they retire from work and how best to achieve their goals. Dale earns $100,000 a year in finance, Daphne earns $98,000 in education.
“What is a reasonable amount we should be targeting to save by retirement?” Dale asks in an e-mail. He asks, too, what amount they should aim to spend. They describe themselves as frugal spenders who want to do some travelling.
He has a defined contribution pension plan at work, while she has a defined benefit plan.
In the meantime, they have the usual house-related upkeep planned in the next few years, including new landscaping and bathroom renovations. They wonder what to do with the $86,000 they have sitting in cash in their bank accounts and tax-free savings accounts, and what other investment strategies they should be pursuing “given that we are not extremely sophisticated investors,” Dale writes.
If they fall short, “Is a reverse mortgage a possibility to finance our retirement?” he asks. They plan to retire in 2032, when he will be 65 and she will be 60.
We asked Ian Calvert, portfolio manager and financial planner at HighView Financial Group in Toronto, to look at Daphne and Dale’s situation.
What the expert says
First, Mr. Calvert looks at the couple’s cash. “Their TFSAs are a great place to invest the $86,000 for the long term,” the planner says, but they also have a line of credit outstanding for $59,000 at 4.45 per cent that is not tax-deductible.
“That should also be considered,” he says, because the interest they are paying on the credit line may be higher than the rate of return they are earning on their mutual fund portfolio. “If this is the case, it would be an immediate and guaranteed after-tax return by eliminating this debt faster.”
Dale and Daphne should rethink how they are using their TFSAs with a view to making them part of their long-term investment strategy, Mr. Calvert says. “The majority of Dale’s and all of Daphne’s TFSA is held in a savings account earning 1.05 per cent,” he says. “Using their TFSAs to invest would help them achieve their retirement goals faster.” Their investment strategy would include interest-bearing securities as well as stocks to provide dividends and growth.
“Due to the stability of Daphne’s defined benefit pension, which will provide predictable income ($53,000 a year) throughout their retirement, they should be comfortable and confident holding some equities in their other retirement accounts,” Mr. Calvert says.
By the time they retire in 2032, if they keep contributing the same amount to their pension plans, and start contributing $6,000 each to their TFSAs every year, they will have a net worth of about $1.75-million, the planner says. (This excludes the commuted value of Daphne’s pension.) Of this, $875,000 would be real estate and the other $875,000 their investment portfolio.
They appear to have the capacity to increase their investable assets, so they should capitalize on the next 10 to 12 years while they are still working, Mr. Calvert says. “With a monthly cash flow surplus of $2,230, it is essential they utilize these funds appropriately during their working years.” (This assumes they have not understated their spending.)
Dale could be contributing an additional $8,000 a year to his personal RRSP, the planner says. This would add $140,000 to their retirement savings, assuming an annualized return of 5 per cent. The RRSP contributions would also provide a valuable deduction from Dale’s taxable income.
Topping up Dale’s RRSP and both their TFSAs would still leave them enough money for an emergency fund and the house projects they wish to complete over the next three or four years, the planner says.
This would put them in a position to have a pretax family income of about $108,000 a year in the first five years of retirement before Daphne begins collecting government benefits. The $108,000 would consist of Daphne’s work pension, Dale’s minimum withdrawals from his registered retirement income fund (RRIF) and his life income fund from a previous employer (LIF), and Dale’s Canada Pension Plan and Old Age Security benefits.
In 2037, when Daphne turns 65 and begins collecting government benefits, the family income will increase to about $148,000. By then, her indexed pension will have risen. As well, Dale’s government benefits and minimum portfolio withdrawals will have risen because they are tied to inflation and age. The income breaks down as follows: his CPP $22,000; her CPP $17,500; her work pension $56,000; his OAS $10,000; her OAS $10,000; his RRSP/RRIF $24,000; his LIF $8,500.
“Having a retirement income of $148,000 a year (before tax) would be ideal because it would accomplish two important goals,” Mr. Calvert says.
First, it would be a healthy withdrawal rate from the portfolio. Dale would be taking the minimum amounts from both his LIF and RRIF while ideally continuing to build up both TFSAs, the planner says. Second, after splitting their eligible pension income, they would each be earning about $74,000 a year. This would ensure they do not lose any of their OAS payments, “an important pillar of their retirement cash flow plan.”
Dale and Daphne ask whether a reverse mortgage might make sense for them at some point. A reverse mortgage is a loan that allows homeowners to access the equity in their home, tax-free, without selling the home. This type of financial product will come with an interest rate that is higher than a typical mortgage, as well as appraisal, legal and other administrative fees, the planner says. The interest accrues every month and the loan is paid back when the homeowner sells the property or dies.
“Although a reverse mortgage can be useful in very specific financial situations, and is attractive because the funds are received tax-free, it should really be viewed as a final option for one who is real estate rich, cash poor and does not rely on the equity of their house later in life,” Mr. Calvert says.
“The major risk with a reverse mortgage is the erosion of equity as the debt compounds over time,” he adds. “This has the potential to become a very large number.” Dale and Daphne wouldn’t want to put themselves in a situation where they’d be forced to move into a nursing home, their monthly expenses would rise substantially, and they’d no longer have the injection of capital that would come from the sale of their house to support their living expenses, he says.
“With one solid pension, government benefits and their estimated retirement savings, Dale and Daphne would likely never need a reverse mortgage if they can comfortably live within a retirement family income of $148,000 a year,” the planner says.
The people: Dale, 53, Daphne, 47, and their daughter, 9
The problem: How much do they need to save for retirement, how much can they expect to spend and how can they best achieve their goals?
The plan: Continue saving with an emphasis on Dale’s RRSP and their TFSAs, consider paying off HELOC, consider adding some equities to long-term investment portfolio.
The payoff: Financial security
Monthly net income: $10,600 (after taxes and pension contributions)
Assets: Cash including TFSAs $86,470; house $670,000; commuted value of her DB pension $403,000; his DC pension $3,500; RESP $28,825; his pension from previous employer (locked-in retirement account) $63,000; his personal RRSP $120,000. Total: $1.37-million
Monthly outlays: Mortgage $1,660; utilities $590; property tax $300; home insurance $340; house maintenance $220; groceries $560; car maintenance $450; car loan $310; car insurance $370; child care $320; HELOC $860; charity $670; vacation, entertainment $250; personal care $250; life insurance $350; subscriptions $230; RESP $240; TFSAs $400. Total: $8,370. Surplus: $2,230
Liabilities: Mortgage $152,600; line of credit $59,000; car loan $11,000. Total: $222,600
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Some details may be changed to protect the privacy of the persons profiled.
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