In Ontario, a couple we’ll call David, 51, and Elizabeth 50, are edging into retirement. Due to health issues, David is unemployed. He receives a medical work pension of $33,408 per year before tax. Elizabeth, a federal government employee, earns $104,196 per year before tax. Their present combined after-tax income is $7,700 per month. She wants to retire in five years at age 55 when she is eligible for a pension of about half her present salary after 25 years of service. They have no children.
The couple is planning to have Elizabeth’s parents, in their 80s, move to live with them. To make that happen, David and Elizabeth would want to build a $500,000 house, financing it in part by selling their present $400,000 house. Combining two generations in one house would be financially efficient, but the precise cost-sharing arrangements would have to be worked out. The reduction in expenses could be an opportunity to create capital reserves for future spending or unexpected problems, or to increase discretionary spending.
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based investment advisory firm Exponent Investment Management Inc., to work with the couple.
The good news is that David and Elizabeth have no debt. Their property taxes are $346 per month for their house and $149 for the adjacent land they can use for a new house. Their present total spending — that is, consumption without investments — is $4,000 per month. In retirement, Elizabeth figures they would need to match this spending plus $1,000 for travel, making target retirement income $5,000 per month after tax.
David and Elizabeth, conservative savers for many decades, have a diversified portfolio consisting of their $400,000 house, a $250,000 vacant lot, $176,000 in non-registered securities, $308,000 in RRSPs, a $20,000 Registered Disability Savings Plan for David, $192,000 in TFSAs, and a $7,000 car. They have no liabilities. It adds up to net worth of $1,353,000.
David and Elizabeth want to build a new home on their land. Assuming that construction costs do not rise greatly, they would need to sell their current home with a $400,000 estimated value. They could net $370,000 after selling costs. A mortgage would cover the $130,000 difference for a $500,000 house. A 30-year mortgage at five per cent would cost $700 per month, easily covered by reducing savings in retirement or payable out of the couple’s robust TFSA with a current balance of $192,000. Given the chance that mortgage rates may rise in the present inflation, they could consider locking in a rate with a lender, Einarson suggests.
They have $176,000 in non-registered investments to which they add $27,900 per year. With five more years of contributions and growth at three per cent after inflation they will have $356,300. Assuming three per cent growth after inflation, the fund will generate $14,965 per year to exhaustion of all capital and income in 40 years.
Their $308,000 in RRSPs growing with $4,500 present annual contributions to David’s 55th year would hold $381,664, assuming a three per cent annual return after inflation. Those registered assets would then generate $16,030 annual or $1,336 monthly income before tax for the 40 years from Elizabeth’s retirement at 55 to her age 95.
In retirement, starting when David is 55, they could use his $33,408 combined annual work pension and CPP disability benefit and, a few months later add Elizabeth’s $53,136 work pension including a $10,140 annual bridge to 65. Those pensions when combined would generate $86,544 per year or $7,212 per month before tax.
Adding $16,030 from RRSPs and $14,965 non-registered investments to income would bring the total to $117,539 per year. After splits of income and average 17 per cent income tax, they would have $8,130 per month to spend.
At 65, David would shift to a conventional CPP pension of $15,048 per year and add his OAS at the present rate of $8,000 per year plus RRSP payouts of $16,030 per year and $14,965 from non-registered assets. A few months later at her age 65, add her $53,136 annual work pension and $8,000 OAS and they would have $115,179 annual pre-tax income. After 17-per-cent average tax, they would have $95,600 per year or $7,966 per month to spend. At every stage of retirement, they would be over their $5,000 retirement target minimum after-tax income.
Their $192,000 TFSA balance growing with $12,000 annual contributions should rise to a value of $288,202 in five years assuming a three-per-cent rate of return after inflation. That would support an income stream of $12,100 per year for 40 years for replacement of their present 2013 car, house upgrades, mortgage paydown or other capital outlays. These would be lumpy costs that are not part of a regular budget. Therefore we’ll exclude TFSA cash flow from the family’s regular spending.
Elizabeth’s parents, expecting to live with them in the new house, would contribute to living costs. After all, they would no longer have to cover their own housing costs. But there are a lot of unknowns — whether and when the house will be built, life expectancy, generational differences, testamentary issues and tax planning.
Their cash flow will enable them to up-size the home, Einarson explains. “If Elizabeth’s parents contribute to costs of housing and food, David and Elizabeth will have more liquidity and more choices. If they combine their incomes with the parents’ incomes and if they share costs, the savings of having just one residence will pay for travel and other pleasures. The move up would be a work in progress, balancing higher total costs of living with cost sharing.” The saying that two can live as cheaply as one is all the more true for four and two.
Retirement stars: Five ***** out of 5