A couple we’ll call Tom, 59, and Millie, 52, live in Toronto where they work respectively, in scientific research and accounting. They bring home $16,900 per month. They have one son heading for graduate studies.
They have done well in financial terms and can retire comfortably, as we’ll see. Their problem is how best to use their ample income and high savings rate. Part of their good fortune — $1.8 million in property or 55 per cent of their net worth — is a result of the hot real estate market in the Greater Toronto Area. For long-term planning, more diversification is wise, especially for folks with less time to recover from a flop in their largest investment by sector.
The couple’s take-home income is more than sufficient for their modest spending, $5,484 per month. Savings, including RRSPs, TFSAs and non-registered investments total $11,416 per month. Frugal, they have no car, and travel by streetcar. They estimate their son’s costs will be $240,000 over four years, half for tuition and the remainder for living expenses on campus. Some can be paid out of his $108,000 RESP.
Tom and Millie would like to have retirement income of $9,000 per month in six years when he is 65 and she is 58.
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Tom and Millie.
The couple’s current assets are their $1.2 million house, their $600,000 rental property $357,000 of RRSP investments for Millie and $69,000 of RRSP assets for Tom. They also have $263,000 in TFSAs, $589,300 in taxable investments and $108,000 in their son’s RESP. Take off the $150,000 balance on the mortgage on their rental property and they have net worth of $3,036,300.
The rental, for which they paid $410,000, brings in $1,700 per month. The current interest rate for the ten years left on their mortgage, 2.39 per cent, poses the question of whether they should pay it off with their available capital or let it ride and use cash flow for retirement savings. Retention is problematic for its costs include $417 mortgage interest, $500 in condo fees plus $300 in miscellaneous costs. That’s a total of $1,217 per month leaving a $483 net monthly return or $5,796 per year.
If they keep adding $18,000 per year to their RRSPs, which have present balance of $426,000, the accounts will grow in six years when Tom retires to a balance of $628,590 assuming a rate of growth of three per cent after inflation. That balance would then support $29,932 annual income or $2,494 per month to Millie’s age 90.
Their non-registered account with a current value of $589,300 with no further additions growing at three per cent per year after inflation would rise to a value of $703,660 in the next six years and then provide $39,232 per year or $3,270 per month for the following 25 years.
Their TFSAs, with a $263,000 present balance plus combined contributions of $12,000 per year for six years to Tom’s retirement would grow to $394,000 and then pay $21,950 per year or $1,830 per month for the 25 years to Millie’s age 90, total $96,910.
Six years from now at age 65, Tom will be entitled to a defined-benefit pension of $6,040 per month or $72,480 per year, $642 monthly/$7,707 annual OAS at present rates, and CPP of $1,200 per month or $14,400 per year. With the rental income, that adds up to $191,497.
Add Millie’s $100,000 pre-tax income and total income rises to $291,497 before tax. With no tax on TFSA cash flow, splits of eligible income and clawback of $617 of Tom’s OAS, after 22 per cent average tax, they would have $231,580 to spend each year. That’s $19,300 per month, far ahead of their $9,000 monthly income goal.
Seven years later, Millie will retire, lose her $100,000 salary and be able to add her own CPP at an estimated rate of $8,000 per year or $666 per month and her OAS of $7,707 per year or $642 per month. Their pre-tax income would decline to $207,204. Assuming splits of eligible income that would eliminate the clawback and 20 per cent average tax, they would have $170,153 per year or $14,180 per month to spend, still well ahead of their goal.
With such a surplus over target retirement income, should Tom and Millie keep the rental or sell? Its return on their $450,000 equity is one per cent, not much for the trouble and risk of ownership. They could do better in other assets. With their house included, they have 58 per cent of their net worth in two properties. If they sell the rental and obtain $418,500 after seven per cent costs and elimination of their mortgage, then invest at three per cent after inflation, they could have $12,560 pre-tax dollars, which is three times their current one per cent annual return from the rental.
We have calculated retirement income with and without the rental. Either way, the couple will have a large surplus for many decades. The use for that surplus for the many years of their retirement is not a financial question. Tom and Millie can donate money to their choice of good causes, add to their estate for their son, or retire much sooner with growth of savings. The issue is both a test of portfolio management and planning and a potential opportunity of ending careers with a broad purpose of helping others. It’s the couple’s choice.
“It’s not just a question of how to make money, but preserving it and using it wisely,” Einarson explains. “This family has achieved almost bulletproof retirement savings and a large fund to help their son in med school. Few plans are this strong.”
Five retirement stars ***** out of Five