The challenge, expert notes, is to find a way for a person with a modest income and pension plan to retire before 65
A woman we’ll call Julia, 51, lives in B.C. She works in a school helping special needs kids. Her income, $3,100 per month after tax plus a $100 monthly gas allowance, covers $2,763 per month of expenses including $400 for her mortgage on her $410,000 condo, $303 monthly strata fees (also known as condo fees outside of B.C.) and $100 monthly property taxes. Single, she has to manage on what is a low income in her province. Her plan — work another five years, then retire, when she will be able to travel much more than the two weeks per year that has been her custom. The question — can it work on a modest retirement income and without part-time work?
Family Finance asked Eliott Einarson, a financial planner with Ottawa-based Exponent Investment Management Inc., to work with Julia. The challenge, he notes is to find a way for a person with a modest income and pension plan to retire before 65.
Present finances
The good news is that Julia has managed to build $346,000 of equity in her home while taking a few trips a year. She hopes to travel a good deal more when retired, especially when costs are low in various out-of-season periods, and to keep her way of life going much as it is now until age 60. Then her pension of $1,559 per month plus $537-per-month bridge to 65, will provide $2,096 per month or $25,152 per year. She will be able to take an estimated $462 per month Canada Pension Plan benefits at age 60 and Old Age Security at $635 per month at age 65. Will this pre-tax cash flow support her retirement?
She has a couple of advantages to realizing her plan. Her investment portfolio has done well, rising about 60 per cent from $89,000 before the COVID-19 lockdowns to a recent value of $143,000. Moreover, her aging parents, ages 81 and 91, will leave their estate to her.
Capital management
She wants to retire on her income and assets alone. Her present net worth, $501,000, is the basis of her retirement plan.
Julia sees paying off her $64,000 mortgage as a priority. It has about 14 years to run. If she were to pay it off entirely within the next five years so that it would be finished at her age 56, she would have to increase her monthly payments by $713, which is more than her budget will support. The better plan would be to maintain her amortization and retire at 60. At that time, she could take $2,096 pension and bridge benefit plus $462 CPP.
As well, her RRSPs, with a recent value of $143,000 and $1,200 annual contributions will grow to $199,140 in nine years when she is 60, assuming a three per cent annual rate of return. The RRSP would then be able to support a taxable annual payout of $9,864 per year or $822 per month for the following 30 years to her age 90.
These taxable sources of income at age 60 add up to $40,560 per year or $3,380 per month. After 11 per cent average tax, she would have $3,008 per month to spend. That works out to a replacement of 94 per cent of her present $3,200 monthly after tax income, but with her mortgage ended at 65 and no further TFSA or RRSP savings, she would have an income surplus of about $1,000 per month. At 65, her OAS benefit, $635 per month, would lift income to $4,015 per month. After 14 per cent average tax, she would have $3,450 per month to spend.
Her tax-free savings account, with a present balance of $7,000, would grow to $29,224 in nine years with $1,920 annual contributions and growth at 3 per cent per year. She can keep the TFSA for unplanned expenses such as replacing her car, present estimated value $6,000.
Income and security
Living on $36,000 at 60 and $41,400 at 65 monthly after-tax income will not be easy. Bargain flights, off-season resorts and other economies will enable this plan to work. We have not estimated long-run returns on investments beyond our customary three per cent for a blended stock and bond portfolio on top of three per cent annual inflation. Her investments are a blend of low-fee ETFs, a few high-fee but very successful mutual funds, and a U.S. asset fund. Julia needs guidance and her portfolio’s appreciation suggests she is getting some value for her fees. Study of investment markets in her retirement would give her a perspective on the risks she faces and future returns she might expect.
However, when her parents pass away, which might be a decade or two, she can expect an inheritance of presently unknown value. We cannot time the event or estimate what she might get after final tax returns. Nevertheless, using today’s numbers, a six-figure inheritance — subject to unknown market changes and taxes, will probably produce a six-figure net sum. Assuming a value of $500,000 invested at three per cent per year, she would be able to add $15,000 to her income subject to 11 per cent tax, net $13,350 per year. That would be a significant addition to her pre-inheritance income. We do not include that in our projections.
As a cost-saving measure, Julia can use the abundant free time she will have in retirement to schedule travel to low seasons. On the other hand, she may face unknown strata (condo) fee increases and future costs of a new or newer car.
The income this analysis estimates will have a sufficient surplus for a car update and modest increases in strata fees. Should Julia decide that a three or more decade retirement is boring without work, she can add to income with tax rates using pension and age credits likely to be modest or make substantial contributions to her TFSA with no tax consequences.
She will also have the gift of being able to time her spending and shopping without competition from work. “On the whole, her situation is good. Her present assets are rather modest, but time is on her side,” Einarson concludes.
Retirement stars: Three retirement stars *** out of Five
