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Time is ticking for couple struggling to save for retirement — but they have $75,000 in pension income to fall back on

Time is ticking for couple struggling to save for retirement — but they have $75,000 in pension income to fall back on

Situation: Couple wants to have their present take home income in retirement and has 17 years to make it happen

Solution: Use HELOC to pay off expensive timeshare loan and bank on company pensions to achieve their goal

In Ontario, a couple we’ll call Louis, 48, and Sally, 42, are raising two children, Kim, 15, and Pat, 12. They are employed by large companies, Louis in information technology and Sally at a research firm. Sally’s company provides extensive benefits for children attending university. They take home $8,000 monthly but with mortgage payments of $1,084 per month and the costs of feeding and clothing their kids, their ability to save for retirement is limited.

On the plus side, they have recently received a $60,000 inheritance and their net worth is solid at $1,040,843. Their mortgage, just $86,020 on their $550,000 house, is also relatively small. There are issues however, such as a $42,000 loan with a 13 per cent rate of interest for a time share. The clock is ticking, for they have just 17 years to pay down those debts and finance their retirement, which will begin when Louis is 65.

“We’d like to have $8,000 after tax per month in retirement,” Sally explains. “That’s what we have now. Can we do that in just 17 years to retirement?”

(E-mail andrew.allentuck@gmail.com for a free Family Finance analysis.)

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Louis and Sally.

Debt management

The first step is to use some of their $79,000 cash buffer to pay down the mortgage, Moran suggests.

“They can use their $60,000 inheritance to pay their $86,020 mortgage,” Moran says. “Their limit for prepayment without penalty is $31,540 per year. The inheritance will allow prepayments without penalty if they do one payment before the mortgage anniversary and the second just after. They can run down the outstanding mortgage balance to $26,020. The amortization will have been reduced from seven years to two years.

Next, use their home equity line of credit (HELOC) to pay the timeshare loan, about $42,000 Canadian. That will cut the interest rate from 13 per cent to a much more reasonable 4.5 per cent. Then they can direct $1,500 monthly general savings to pay it off. That will make it possible to eliminate the loan in about two years.

Education

Louis and Sally have $48,863 in their Registered Education Savings Plan. Sally’s employment contract pays tuition costs for her children at post-secondary institutions. If the kids live at home while attending university, the RESP can be used as a wealth-building tool, Moran explains, whether they need the money for education or not. The parents can continue to add $2,500 per year to the RESP and capture the 20 per cent Canada Education Savings Grant. The grants plus growth will be taxed in the children’s hands. They will be attending a qualifying post-secondary institution, thus meeting the RESP requirements. It would be useful to keep adding money to the RESP, doubling it to $2,500 per child per year and attracting the $500 maximum CESG until each child has maxed out the $7,200 per beneficiary CESG limit, which appears unlikely given the history of contributions to the RESP. However, we will work with the present total $3,000 family annual contribution rate.

The children, now 15 and 12, will see their $48,863 RESP grow to about $75,000 with annual increases of 1.5 per cent after inflation before the CESG additions stop at age 17. University is too close to allow for volatile equities. The low growth rate reflects cautious investments in GICs that can be used for post-graduate degrees if the kids take that path.

Retirement income

Louis and Sally hope for an $8,000 monthly retirement income after tax. Assuming that they have a 20 per cent average tax rate in retirement based on pensions and investment income, they would need about $120,000 before tax. In seven years, when Louis is 55, their $13,000 annual mortgage cost will be history and $2,500 annual RESP contributions will have ended. Their cash on hand will grow.

Their RRSP and defined contribution accounts from former employment add up to about $409,000. Because they are in defined benefit plans, tax rules say they cannot add much to present RRSP balances. However, that sum, growing at three per cent after inflation for 17 years to Louis’ age 65, would become $676,037. Continuing to earn three per cent after inflation, that balance would generate $33,490 before tax for the 30 years to Louis’ age 95 when all income and principal would have been paid out.

Odds of meeting their retirement income target are good. On top of RRSP income there will be pensions. Louis began his present job with a defined benefit retirement plan at age 38. He will have 27 years on the job by age 65. His pension will be based on two per cent of the average of his final five years of income, $104,000, times 27 years of service. That works out to $56,160 per year. It will not be indexed to inflation. He can add $13,855 CPP and $7,290 OAS at 65 for an annual total of $89,650.

Sally, who began her present job with its DB pension this year, can expect 17 years of pension contributions from her employer to the time she is 59 and ready to join Louis in retirement. Using the two per cent of final five years average income, $57,000, times 17 years of employment, she would have $19,380 per year company pension income. At their respective age of 65 and 59, they would have $109,030. After splits of eligible income to and credits and payment of tax at an average 17 per cent rate, they would have $7,540 to spend each month, a bit below their $8,000 target for six years to Sally’s age 65. Taking CPP early at a 36 per cent cut, net $7,093, would end the deficit for five years but at a high cost in later years when the reduced benefit and indexation base would be regretted. A dip into their growing cash savings would close the $460 monthly gap until Sally is 65.

At 65, Sally could add $11,084 CPP and $7,290 OAS. That would push pre-tax income to $127,400 per year. After 18 per cent average tax, they would have $8,700 monthly to spend.

Pension options ensure that when the first spouse dies, the survivor will have adequate funds even with loss of splits of remaining income,” Moran notes.

Retirement stars: 4 **** out of 5

Financial Post

E-mail andrew.allentuck@gmail.com for a free Family Finance analysis.

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