Situation: Couple wants to spend more in retirement than present resources can support
Solution: Downsize house, pay debts, invest balance to boost income, cut spending plans
In Quebec a couple we’ll call Robert, 63, and Tess, 57, are headed into full retirement in two years with one company pension, moderate savings, and a home worth $950,000. Their problem — adjusting to less income when Robert quits his job at 65 and the $90,000 in pre-tax annual income that comes with it. Tess, who is in remission from cancer, has already retired.
They want to have $120,000 per year income before taxes but have resources unlikely to generate that sum. Each will qualify for full Old Age Security benefits at $7,362 per year. They will get less than maximum payouts from the Quebec Pension Plan. Financial assets total $644,000. They have not made RRSP contributions for the last 22 years. They have no Tax-Free Savings Accounts.
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Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Robert and Tess. “The problem is that savings will not support future spending,” the planner explains. “Their RRSPs total $254,000 but that is a moving target with the ups and downs of the market.” They have $112,000 in outstanding loans. Take-home income from Robert’s job is $4,716 per month. In two years, Robert’s job income will end and they will have to live on pension and investment income.
Bridging the gap
Their situation could be thought of as a future tug of war between their savings and their spending, which currently includes $6,000 per year on clothes. The spending can’t be allowed to win, so adjustments of both outlays and income are essential, Nalbantoglu explains.
We need to anticipate Robert’s income when he retires in two years at age 65. He will then receive job pension income of $13,000 per year, Quebec Pension Plan benefits of $10,308 per year and Old Age Security benefits of $7,362 per year. That adds up to $30,670. Tess, who will be 59 in two years, will have no job pension.
Robert can split his job pension with Tess and he will pay about $1,400 in tax, so his net income will be $29,200, not enough to maintain their way of life.
Because Tess will be six years from eligibility for Old Age Security they will need additional sources of income to bridge the gap.
One option would be to tap her RRSP, which has a present value of $102,710, while allowing Robert’s to grow until they are 71 and 65 respectively. Tess could withdraw about $17,000 per year for the six years until her age 65, but that would still only raise their after-tax income to about $43,600.
They would have to tap their house for income as well.
Downsizing the $950,000 house, which has a $100,000 home equity line of credit outstanding, will leave them with $802,500 after five per cent selling costs and loan elimination. They can reserve $500,000 for a new home, leaving $302,500. That can be added to their existing $350,000 in cash and $40,000 in stocks, for a total of $692,500. After reserving $50,000 for emergencies, they’ll have $642,500 to put to work generating income.
Building income
Their first move with that cash should be to open TFSA accounts and add the 2020 limit, $69,500 each. The $139,000 growing at three per cent per year after inflation will increase to $147,467 in two years. There will be no further contributions. Starting in two years when Robert is 65, that capital, still generating three per cent per year after inflation, can pay out $6,560 for the 36 years to Tess’s age 95.
The remaining $503,500 could be put into diversified investments with a three per cent annual return. This sum will rise to $534,165 by Robert’s age 65. Assuming that all capital and income are distributed in the following 36 years to Tess’ age 95, it will generate $23,755 per year.
Total income at Robert’s age 65 at retirement thus works out to his $13,000 pension, QPP benefits of $10,308 per year, OAS benefits of $7,362 per year, $23,755 from taxable investments, TFSA distributions of $6,560 and Tess’s draw of $17,000 from her RRSP. The total is $77,985. With splits of eligible income and no tax on TFSA distributions, they would pay 17 per cent average tax and have about $5,500 to spend per month. That exceeds present spending.
At age 60, Tess will be eligible for QPP benefits. She can expect only $2,280 annual QPP benefits at 60. After splits of eligible income and tax at 18 per cent with no tax on TFSA drawdowns, they would have about $5,650 per month to spend.
While they are well below their target income, they will have more than enough to pay the bill, which also should decline in retirement. Spending for a $500 monthly car loan ends in two years when the $12,000 balance is paid. A downsized house might cost $200 dollars less a month for utilities and property taxes. They could also spend a little less on clothing and grooming to free up income for other pursuits.
When Tess turns 65, she will have exhausted her own RRSP and lose the $17,000 payout, but will be eligible for OAS benefits of $7,362 per year. Robert’s RRSP, which would have been steadily growing, could also be tapped.
Assuming it has been growing at three per cent, the original $151,290 would have grown to $191,700 and could pay out $9,500 per year to the couple’s income for 30 years to Tess’s age 95.
Taken together, those two payouts would almost exactly cancel out the lost income from Tess’s RRSP, leaving them with the same $5,650 in after-tax monthly income.
The biggest risk to this plan would be the death of one partner, which will cost them one OAS benefit as well as some QPP and income splitting.
If they build a reserve, they can cover that loss.
Retirement stars: Three *** out of five
Financial Post
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