Couple Spending Nearly a Third of Income Servicing Debt Needs a Plan to Meet Retirement Goals

Situation: Couple spends a third of take-home income on debts, needs to raise retirement savings

Not far from Toronto, a couple we’ll call Herb and Torri, both 45, have a thriving life. Herb works as a senior manager for a food company, and Torri has a part-time job in the provincial government. Together, they bring home $9,314 a month from their jobs.

Their problem, in a nutshell, is that they can’t afford their way of life. They live in a house with an estimated market value of $1.1 million, which is most of their wealth — their financial assets are more modest: They have $382,200 in savings, all of it in RRSPs, and a $47,100 Registered Education Savings Plan (RESP) for their children, ages 14 and 17.

Current Financial Challenges

Living well is costly. Their mortgage, line of credit payments, and property taxes eat up a total of $2,652 each month — 28% of their regular take-home income. Sometimes short of money, they use their line of credit, then pay it down the next year with Herb’s year-end bonus and by exercising his stock options. Neither source is guaranteed.

It’s a rat race, and understandably, they want out. Herb asks, “Could I retire with a $60,000 pre-tax income at 60?”

Financial Plan and Recommendations

Family Finance asked Caroline Nalbantoglu, head of CNal Financial Planning Inc. in Montreal, to work with Herb and Torri. “Expenses are high in relation to their income,” Nalbantoglu says. “Their debt, a total of about $361,700, clings to them. Their goal is to be debt-free, hopefully before their anticipated retirement age of 60.”

Nalbantoglu suggests that the road map to debt reduction can start in 2017 when Herb, then 46, gets his bonus and exercises his stock options. He should get a combined total of $62,000 after tax. If he uses $10,000 a year for accelerated mortgage payments, then their mortgage, with 17 years to go, would be cut down to 11 years, and paid off three years before their projected retirement age of 60.

Another $10,000 from the annual bonus and stock options can be used for paying down the line of credit, which would be gone in four years or less. The remaining $42,000 can go to savings. Neither Herb nor Torri has a Tax-Free Savings Account (TFSA), so each has $46,500 of TFSA room this year. With the available funds left after accelerated mortgage payments and renovations or travel, they could each put $21,000 into TFSAs. By 2019, they will have reached their cumulative limit, then $57,500 with $5,500 annual contributions, and there will be a surplus, which can go to Torri’s non-registered savings. She will always be in a lower tax bracket than Herb.

Future Financial Planning

At present, Herb contributes five percent of his gross pay to a group RRSP with a 100 percent match by his employer. Next year, he will be able to put in six percent with a 100 percent match. He already puts $325 a month in his RRSP, so total contributions are $650 a month. Torri puts $200 a month into her RRSP with no match. Most of the family RRSP savings will be in Herb’s name, so his future contributions should go to a spousal plan for Torri, Nalbantoglu suggests.

With this rate of saving, by the time they are 60, they will have $960,000 in Herb’s RRSP and $237,000 in Torri’s RRSP. Their TFSAs and non-registered savings will be $324,000, Nalbantoglu estimates.

By the time their mortgage is paid off at age 60, their present monthly expenses of $9,314 will have declined. They will no longer need to make mortgage or line of credit payments, will have paid off a loan from a relative, and won’t be making monthly deposits to their savings or paying for their children’s activities. Their budget will be $4,710 per month.

If they retire at 60, they can use their RRSPs or TFSAs and non-registered savings. Herb should get the maximum CPP benefit of $13,110 a year reduced by 36 per cent for retirement at 60, netting $8,390 a year. If Torri gets half the maximum, she would have $4,195 a year. If they each take $25,000 from their RRSPs — which would be $275,000 from each for eleven years to age 71, when their RRSPs would be converted to RRIFs — their pre-tax income would be $62,585, a little above the $60,000 target. After average tax of 14 percent, they would have $53,900 a year or $4,485 a month to spend. That would be $225 short of their budget, but cash taken from their TFSAs and non-registered savings would easily make up the difference, the planner notes.

Conclusion

Each will receive full Old Age Security benefits at age 65 — $13,692 total. On top of other income, they would have a total pre-tax income of $76,277 a year. After splits of eligible pension income from RRSPs and no tax on TFSA payouts, they could pay 12 percent average tax and have take-home income of $5,600 a month, more than enough to cover recurring retirement expenses.

At age 71, Torri’s RRSP would be depleted. Herb’s RRSPs would have grown to $998,400, even after his withdrawals. At age 72, when RRIF withdrawals must start, he can take money out of his RRIF at the prescribed rate, 5.28 percent in his first year. He would have $52,715 of taxable income. His total income including CPP and OAS would be $67,950, well below the present OAS clawback trigger point of $72,809. Torri would have CPP and OAS income of $11,040. Each could take money out of TFSAs with no tax consequence. Their total pre-tax income would be $79,000. With splits of eligible pension income, they would pay 10 percent average income tax and have about $5,925 a month to spend, more than enough to cover recurring expenses.

“Their portfolio needs direction and cost reduction,” Nalbantoglu says. Swapping high-fee funds for ETFs would save a few thousand dollars a year. Investment grade corporate bonds with terms of 10 years or less would stabilize the portfolio. Moreover, if they get off their line of credit roller coaster, this couple can have a secure retirement beginning at 60, the planner says. “These steps can be taken gradually, but when their financial assets are restructured, their lives will be more secure.”

For more details on this case, you can read the full article in the Financial Post here.