At age 52, Barry and Beth are enjoying their peak earning years, bringing in a combined salary of more than $450,000 a year. He works in education, she is a senior executive at an investment firm. They have two children in university.
Beth and Barry have a $2-million house in Toronto with about $150,000 in mortgages against it, plus a line of credit for $115,000.
Short term, their goals are to continue to fund their children’s education, build their retirement savings and take a “significant trip,” Beth writes in an e-mail. Barry has a defined benefit pension plan partially indexed to inflation, while Beth has a defined contribution plan. She also stands to get substantial bonuses, depending on her firm’s performance, but she has asked that these not be included in the financial forecast because they are not guaranteed.
Longer term, they hope to help their children with down payments on their first homes. Their goal is to retire from work at age 62 with a budget of $12,000 a month, or $144,000 a year.
“Are we saving enough for retirement?” Beth asks. “If yes, are we in a position to retire before age 65?”
We asked Matthew Sears, a certified financial planner at TE Wealth in Toronto, to look at Beth and Barry’s situation. Mr. Sears also holds the chartered financial analyst (CFA) designation.
What the expert says
Until recently, Beth and Barry had been sinking as much as they could into their mortgages and line of credit, Mr. Sears says. With the recent rise in interest rates, though, they decided to direct the cash flow from the mortgages to savings with a view to repaying the loans in full when they come due in late 2024 and early 2025. The balances at maturity will be about $57,000 and $60,000.
Their line of credit is projected to be paid off in the next two years. “I wouldn’t recommend that they do anything risky with those funds if they want them to be available in 2024 and 2025.” Some sort of guaranteed investment would be suitable.
Mr. Sears suggests they focus on paying down the line of credit first before investing or redirecting the funds to savings. They are paying 4.2 percent on the credit line. Beth is in a 53.53 percent marginal tax bracket and Barry 43.41 percent. That means they would have to generate pretax rates of return of 9 percent for Beth and 7.4 percent for Barry, to be further ahead than paying off the 4.2 percent line of credit, he says. That assumes they would be earning interest or foreign dividend income.
If they were earning Canadian dividend income, which is taxed more favorably, Beth would have to be making 6.19 percent and Barry 5.62 percent, the planner says.
Interest rates could also rise, further increasing the cost of the line of credit.
“Redirecting the monthly surplus would have the LOC paid off in 12 months,” the planner says. To pay it off sooner, they could sell the $32,000 in stock they own in their taxable account, which has a large capital loss built into it. “They could realize the loss and direct the sale proceeds to the LOC.”
Alternatively, this could be used to max out their TFSAs, but they would need to be aware of the superficial loss rule, he says.
“Since they have a loss, they should not just transfer the shares in kind into a TFSA. They should sell and contribute the cash to the TFSA,” Mr. Sears says. “When the contribution to the TFSA is done, they should not buy back the shares within a 30-day period or else the loss would be considered a superficial loss.” There wouldn’t be an issue if they choose to invest the funds in something else.
After the mortgages and line of credit are paid off, Barry and Beth could redirect the amount they were paying ($1,300 on the mortgages and $5,000 on the LOC) plus their monthly surplus of about $4,600, to retirement savings starting in March of 2025, Mr. . Sears says. “The goal of retiring at age 62 is only 95 percent met with this,” the planner says. To fully meet their goal, they would need to save an additional $3,700 a month from 2025 to 2032.
To summarize the savings plan, Barry and Beth direct $9,600 toward the line of credit from now until July, 2023. Starting in August, 2024, they either direct the $9,600 to risk-free investments such as GICs or toward the mortgages. If they set the funds aside in GICs, they would then use the money to pay off the mortgages in full in 2024 and 2025. Then, starting in 2025, they would direct both the $1,300 a month that had been going to the mortgages and the $9,600 that had been going to the line of credit to retirement savings instead.
“Another way to look at it is they need about $2,947,000 of investable assets to sustain their retirement spending goal,” Mr. Sears says. In the above forecast, their maximum sustainable spending is $11,500 a month, which is very close to their monthly retirement spending goal.
The forecast assumes Beth and Barry retire in January, 2033, begin collecting Canada Pension Plan and Old Age Security benefits at age 65 and live to be age 95. Barry gets a pension of $5,090 a month starting at age 62. The rate of return on their investments average 5.45 percent and inflation 2.2 percent.
Beth contributes 4 percent of her salary to her defined contribution pension plan with a 100-percent employer match.
A lower rate of return would change things a bit. “If we lowered the expected rate of return by one percentage point in retirement, they would reach only 85 percent of their spending target,” Mr. Sears says. “Maximum sustainable expenses would be $10,000 a month. Instead of $2,947,000 to achieve their $12,000 a month spending goal, they would need $3.25-million of investment assets.”
One item that isn’t accounted for is Beth’s annual discretionary bonuses, which they prefer not to count on in their planning, Mr. Sears notes.
“If the bonuses were paid out each year and added to savings, this would make up for the shortfall needed to meet the retirement spending goal.”
Once debt is paid off and savings are removed, Barry and Beth’s current lifestyle spending will be about $8,275 a month, which is about 70 percent of their retirement spending goal, Mr. Sears notes.
The people: Barry and Beth, both age 52, and their children, 19 and 21
The problem: Are they saving enough to retire at age 62 with $12,000 a month?
The plan: Pay off the line of credit, then the mortgages and redirect the cash flow plus any surplus to their long-term retirement savings. If they’re a bit short, saving any bonuses Beth might get would float them onside.
The payoff: A clear path to the retirement goals they seek.
Monthly net income: $24,715
Assets: Stocks $32,000; residence $2-million; her TFSA $53,000; his TFSA $43,000; her RRSP $457,000; his RRSP $112,000; her locked-in retirement account from previous employer $202,000; her DC pension plan $134,000; estimated present value of his DB pension plan $375,000; registered education savings plan $70,000. Total: $3.48-million
Monthly outlays: Mortgage $1,300; property tax $675; water, sewer, garbage $150; home insurance $175; electricity, heat $350; security $35; maintenance $300; save $100; transportation $875; groceries $1,000; university tuition $1,500; clothing $500; line of credit $5,000; gifts, charity $850; vacation, travel $250; dining, drinks, entertainment $1,100; personal care $100; pets $200; sports, hobbies $200; doctors, dentists, drugstore $125; health, dental insurance $505; life insurance $785; communications $500; RRSPs $500; TFSAs $1,000; pension plan contributions $1,980. Total: $20,055. Surplus $4,660
Liabilities: Mortgage $72,995 at 1.62 percent; mortgage $78,185 at 1.67 percent; line of credit $115,000 at 4.2 percent. Total: $266,180
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