Couple with under $200K in assets needs to pay down debt to make retirement math work

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East coast couple has to realize that balancing costs and income will be a challenge

In Nova Scotia, a couple we’ll call Vern and Lucy, both 54, have take home incomes which total $61,200 per year. They work in metal sales and the chemical industries, respectively. They have no children. They would like to retire at age 62 in eight years. Their preparations for retirement are modest. They fear ending their work years with their present $184,410 sum of debts and no way of being debt-free. They need a solution.

As they have considered the way they want to live in retirement and the ways of financing the costs of retirement, they have come to the realization that balancing costs and income to pay those costs will be a challenge.

Their total savings are $78,640 in their RRSP invested in mutual funds. Lucy has a defined benefit pension. Each will have full Old Age Security at 65 and Canada Pension Plan benefits.

Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Vern and Lucy.

Reaching a retirement income goal

Their goal is retirement income of $6,000 per month before tax. Assuming they continue to live in their present home, which has a remaining mortgage debt of $128,410 and can pay off their outstanding $36,000 car loan, a $20,000 line of credit with a 7.55 per cent interest rate as well as their mortgage and a small credit card balance with a 12 per cent interest rate, they could make it. The couple has net worth of $194,230.

The issues are whether to pay off their mortgage before retiring or sell the house when it is mortgage-free, when to start CPP and whether they should maintain life insurance.

The questions and their retirement finance problem turn on their needs after they stop work and their ability to add to savings and other retirement resources before retirement. First, we need to assess how much they may need in retirement.

Currently, Vern adds $147 to his RRSP each month matched by his employer for total contributions of $294 per month or $3,528 per year. In retirement, they will no longer have to save, so they can switch the $143 per month now going to RRSPs to their current budget. Their mortgage, which has about a decade to run, should be paid off after about 120 months of $1,120 payments. Their $516 monthly car loan payment and $130 monthly line-of-credit payment will also be history. As well, $177 per month they pay for life insurance can be stopped: When all their loans are paid in full, they will not need life insurance to cover the debts. Thus $2,086 monthly costs will be gone.

There are other options, Einarson explains. They could accelerate mortgage payments to be rid of it in eight years. That would push payments from $1,195 per month to $1,670 per month with an average two per cent interest cost. But that expense would break their budget and make them house poor. However, stretching a new mortgage over 11 years to age 65 would be acceptable. Their payments would come to $1,250 per month.

Retirement income

Vern’s RRSP with a present balance of $78,640 with $3,528 in total annual contributions (including employer match) at three per cent annual growth will rise to $155,400 in 11 years and the support payments of $8,670 per year to his age 90. If Vern defers his CPP benefit from the earliest date he can start to 65, he can have $9,384 taxable income. His Old Age Security will be $7,623 per year. Lucy has a defined benefit pension that will pay her $24,084 per year. Her CPP will be $11,556 if she works to 65 and OAS $7,623. The sum of their age-65 cash flows will be $68,940 before tax. After splits of eligible income and 15 per cent average tax, they would have $58,600 per year to spend or $4,883 per month. They will exceed their $60,000 annual pre-tax income goal. As their debts are paid down, their discretionary budget will rise and provide money for travel, home repairs and a few luxuries.

There are also ways to add to discretionary spending. They are allocating $177 per month for a combination of term and whole life coverage. They have $100,000 term and $25,000 permanent coverage each. The term component of this coverage package is inexpensive and can be maintained until the mortgage is paid off. The permanent coverage is more complex. If it is substantially paid, it can be kept. If not, it might be put on a premium holiday so that internal growth pays premiums. The choices should be discussed with their insurance agent, Einarson suggests.

The house — sell or hold?

Should their house be sold and capital invested? While in their house, growing street value is not taxed. When sold, the capital gain on their principal residence will not be taxed. This investment provides accommodation. If they sell and rent, then the income they must earn to pay the rent will be taxed. Rents may rise over time more than their retirement income. That suggests a potential cost squeeze that might force them back to work. Keep the house as an asset of growing value that provides shelter. No stock can do that, the planner notes.

Will their retirement work in the terms we have reviewed? Yes, but it requires staying on the job to age 65. Taking retirement at 62 with a 28.8 per cent reduction of CPP would cost them $6,000 per year before tax. They would be hard pressed to afford that income reduction.

“This retirement plan will work as long as Vern and Lucy work to 65 and keep their costs down. Even after retirement, there will not be a great deal of surplus income. “This plan is built on cautious spending and conservative money management,” Einarson concludes.

3 Retirement Stars*** out of 5

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