Herb has two years until he turns 60; he will either have to get another job or the couple will have to rein in costs
Situation: Layoff and meagre settlement package leave husband worrying standard of living will crumble
Solution: Draw down cash savings for monthly income and consider hefty mortgage prepayment
A couple we’ll call Herb, 58 and Marcia, 47, live in Ontario. A graphic arts manager recently let go from a four-decade career, Herb has lost his steady income of $80,000 per year, with only a $40,000 separation cheque to tide him over. Marcia, a health-care professional, brings home $4,500 per month. Understandably, they worry.
Their former monthly take-home income, nearly $9,000 per month, is history, so they have reduced spending substantially. Yet they still have two leased cars that cost them a total of $505 per month, a mortgage with an outstanding balance of $245,000 that will take 28 years to pay off at their current pace and expenses of $310 per month for clothing and grooming. Their problem: adjusting their way of life to substantially reduced income until Marcia’s pension starts.
“Can we maintain our way of life even when my severance package runs out at the end of the year?” Herb asks.
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In the short term, there are only two choices: Either Herb must get another job or they will have to rein in costs until he can start his Canada Pension Plan benefits of $714 per month in two years when he turns 60.
Bridging unemployment
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa’s Exponent Investment Management Inc., to work with Herb and Marcia.
For now, Herb and Marcia have cut their monthly spending to a more sustainable $5,500.
Marcia continues to earn her $87,000 salary, meaning they are about $1,000 in after-tax income short of covering their expenses.
Herb’s settlement can support an after-tax draw of $1,000 per month for at least a couple years, Einarson notes, but not much more.
“They should be able to pay their bills even if Herb does not go back to work,” Einarson says.
Herb can take pressure off the budget by taking early CPP at $8,883 in two years at age 60. Five years later, he can start Old Age Security at $7,217 per year, the current payout rate. His tax rate would be negligible but his cash flow plus Marcia’s income would keep them close to their $5,500 budget.
They would, however, be relying heavily on Marcia’s income, and any disruption to that cash flow would throw a wrench in the works.
Retirement Finance
Because of their age differences, it will be at least 13 years until Marcia turns 60, and both are fully retired.
We’ll do the following calculations assuming that they wait until then before tapping their substantial retirement savings, but if Herb is unable to find a new job, they may in reality decide to shift some of that income forward.
Herb and Marcia want an after-tax monthly retirement income of $6,000.
They have RRSPs worth $385,000, $135,000 in TFSAs, $100,000 cash and taxable assets of $645,000. That adds up to $1,265,000. Their home has an estimated value of $750,000. Take off the $245,000 mortgage, and their equity is $505,000. All that adds up to current net worth of $1,770,000. Each partner will be eligible for Canada Pension Plan and Old Age Security benefits. Marcia will have a defined benefit pension of $45,000 per year starting at age 60.
Their retirement outlook is far from grim. If they allow $600,000 of their present $645,000 of non-registered assets to grow for the next 13 years to Marcia’s age 60 with a 3 per cent return after inflation, they would have $881,135 in 2019 dollars. That capital could support payouts of $43,645 for the next 30 years to Marcia’s age 90 at which time all money in the non-registered account would be paid out. The $45,000 cash balance would either go toward tiding Herb over to retirement or, if he does find a job, could be a reserve for emergencies, Einarson explains.
Their registered assets, currently $385,000 with Marcia still adding $3,000 per year, would grow with the same assumptions to $613,644 in the next 13 years to her age 60. That capital would generate $30,396 per year to her age 90.
Their TFSA, with a present balance of $135,000 and $3,600 annual contributions, would grow to $256,163 in 13 years and support $12,689 of annual tax-free income to her age 90.
At her age 60, Marcia’s company pension would provide a $45,000 annual payout to 65 when her bridge ends. The $8,000 bridge loss would be replaced by CPP benefits. She would add Old Age Security at a present rate of $7,217 per year.
That all adds up to about $147,000 in income at Marcia’s age 60. With income split and taxed at an average 18 per cent rate but no tax on TFSA income, they would have $10,250 per month to spend.
At 65, with the loss of the bridge and addition of OAS, that would rise to $154,500, or $10,750 per month after tax.
When both are retired
Both figures are well above their target, but the problem is in getting from here. Herb and Marcia may want to move the future forward by trading some money then for money now.
Their $245,000 mortgage carries a variable interest rate. Assuming that their 3.0 per cent rate holds for the entire 28-year period, they would pay $1,095 per month. We can guess other rates, but it’s speculation, so we’ll stick with the present rate. That adds up to $367,920 of which $122,920 is interest.
Were they to use $100,000 cash earning just about nothing in the bank to reduce the debt to $145,000, then with the same payments, they could cut 14 years off the mortgage or reduce their month service costs to $638 per month. The savings would be very helpful until Herb gets a job or Marcia retires.
“Decades of saving and prudent spending have created a nearly bulletproof retirement for the couple,” Einarson concludes.
Retirement stars: 4 **** out of 5
