A couple we'll call Tom and Julia, both 63, live in B.C. Their financial lives are secure with take-home income of $7,940 a month, but when they retire at 65, as they plan, they will still have to cope with a mortgage, which has a decade to run before it is paid off, and an outstanding line of credit. They have $685,000 in their RRSPs and $4,000 cash in the bank. Neither has a company pension. They face going into a retirement with reduced income and a mountain of debt.
Tom, a manager in a manufacturing company, and Julia, an administrator for a financial services company, are generous to friends and family, trusting with their advisers, dutiful with their employers. What they are not is skeptical and in that lack of disbelief lies their problem, because they are deeply in debt. The $322,000 they owe creditors is an anchor that may prevent their retirement ship from sailing — or leave it in perilous waters.
“We bought our home 25 years ago but can't seem to pay off our mortgage,” Tom says. “We expect to downsize in a couple of years. We have a basement suite for one of our daughters who lives with us for perhaps another year. The other, a little older, is independent. Can we help the kids buy starter homes We'd give each $25,000 to help with their down payments and then retire in two years Can we also afford a couple of vacations a year that would cost $3,000 to $5,000 each”
Family Finance asked Rod Tyler, head of The Tyler Group in Regina to work with Tom and Julia. “They can't have it all,” he says. “We have to rule out the $25,000 gifts to the children if the couple wants to retire and travel. If we use a time horizon to age 90, there is no margin of safety for the couple after paying off the present mortgage and line of credit.”
The couple's $165,000 mortgage has a 2.45 per cent interest rate and will run about 11 years to 2026. They pay $1,462 a month on it. The $157,000 line of credit has a 3.25 per cent interest rate. They pay $361 a month on it, which is not even sufficient to cover the monthly interest cost of $425.
If they were to raise their payments on the line of credit to $860 a month, they would have it paid off in 21 years. With payments of $1,235 a month, the LOC would be paid off in 13 years. This strategy would leave them in debt to either age 84 or 76, respectively. They should shed debt faster. Best move — downsize the house to liberate cash.
Their house has an estimated selling price of $800,000 in the inflated B.C. market. Were they to unlock its value and sell with five per cent selling and moving costs, they would net $760,000. Eliminate their $165,000 mortgage and the $157,000 line of credit and they would have $438,000 for a new, smaller retirement home. They would be debt-free.
Income and expense
In retirement at 65 with no additional savings, their present $685,000 of RRSPs will have increased to $753,500 in 2015 dollars with two years of contributions at the present rate of $1,060 a month and three per cent annual growth after inflation. If that money is released from RRSPs on an annuitized basis so that all capital is expended by their age 95, it can generate $37,300 a year before tax.
Their total income, including Canada Pension Plan benefits of $12,780 each and Old Age Security benefits of $6,780 each would be $76,420 before tax, or $5,540 a month after 13 per cent average tax. If they give $50,000 to their children, their savings would be reduced to about $703,000 — depending on when they make the gifts — and their annuitized returns to age 95 would decline to $34,800 a year. That would make total annual pre-tax income $73,900 and their after-tax income with a 13 per cent tax rate $5,360 a month.
Cost cutting comes next: Their entertainment budget can be cut in half to $500 a month and restaurants, at $250, could yield a cut of $100 a month. RRSP contributions of $1,060 a month would have ended at age 65 when the couple retires. Three cars are not needed in retirement; one would do, saving perhaps $300 a month. And spending of $284 a month for phone, cable and web could be trimmed by $100 if a cheaper network provider can be found. Their mortgage and LOC payments would also be history. Expenses would be reduced by $3,883 a month to $4,877 a month. Their surplus would be $663 a month, or $483 a month after the gifts to their children.
They could increase the surplus by using the B.C. property tax deferral plan, which allows residents over 55 to postpone their real estate taxes on their new, downsized home until sale of their property at a cost of one per cent of sums deferred each year. Interest does not compound. They could afford a couple of vacations a year at a total cost not exceeding $6,000 to $8,000. Or use their surplus to open tax-free savings accounts, perhaps to accumulate money for a new or newer car from time to time.They could open TFSAs with some of the $4,000 cash they keep in a chequing account.
Julia and Tom have invested their retirement money in a potpourri of mutual funds, many with fees averaging 2.5 per cent. If they can shave one per cent off their fees, then their $685,000 of funds would generate another $6,850 of annual income or $6,350 if they make $25,000 gifts to each of their children. Cost management is the key. The couple must do near the end of their working lives what they should have done decades ago: tighten their belts. It won't be easy. They will have to be less generous when entertaining their friends and paying their financial advisers.
For now, Tom and Julia need to do some homework. They should study economics and investment markets, accounting and even a little math and statistics. They might enroll in an investment course or make use of seminars and tutorials available online for no charge. Several chartered banks offer investment instruction as part of their discount brokerage services. Study is likely to be rewarded with reduced costs for investing and perhaps even higher returns if they make wise investment decisions. Tom and Julia, like many investors, have been taking all the risks and paying high fees to do it. They can't shift risks to anyone else, but they can raise what's left after they pay fund managers and advisers.
If they do acquire the skills required for knowledgeable investing, they will be able to improve their own bookkeeping and question their advisers and understand their own accounts. It is likely to be rewarding, Tyler suggests.