At 52, Barry and Beth are enjoying their best earning years, bringing in a combined salary of more than $450,000 a year. He works in education, she is a senior executive in an investment company. They have two children in college.
Beth and Barry have a $2 million home in Toronto with about $150,000 in mortgages, plus a $115,000 line of credit.
In the short term, their goals are to continue to fund their children’s education, build their retirement savings and take an “important trip,” Beth wrote in an email. Barry has a partially inflation-indexed defined benefit pension plan, while Beth has a defined contribution plan. She is also likely to get substantial bonuses, depending on how her business performs, but she asked that these not be included in the financial forecast as they are not guaranteed.
In the longer term, they hope to help their children put down a down payment on their first home. Their goal is to retire at age 62 with a budget of $12,000 per month, or $144,000 per year.
“Are we saving enough for retirement? Beth asks. “If so, are we able to retire before age 65?
We asked Matthew Sears, a Certified Financial Planner at TE Wealth in Toronto, to look into Beth and Barry’s situation. Mr. Sears also holds the Chartered Financial Analyst (CFA) designation.
What the expert says
Until recently, Beth and Barry were sinking as much as they could into their mortgages and lines of credit, Sears says. With the recent rise in interest rates, however, they have decided to direct mortgage cash flows into savings with a view to repaying loans in full as they mature in late 2024 and early 2025. Balances at maturity will be of approximately $57,000. and $60,000.
Their line of credit is expected to be repaid over the next two years. “I wouldn’t recommend them to do anything risky with these funds if they want them to be available in 2024 and 2025.” Some sort of guaranteed investment would be suitable.
Sears suggests they focus on paying down the line of credit first before investing or redirecting funds to savings. They pay 4.2%. 100 on the line of credit. Beth is in a marginal tax bracket of 53.53% and Barry 43.41%. That means they would need to generate pre-tax rates of return of 9% for Beth and 7.4% for Barry, to be ahead of the 4.2% line of credit repayment, he says. This assumes that they would earn interest or foreign dividend income.
If they earned Canadian dividend income, which is taxed more favorably, Beth should earn 6.19% and Barry 5.62%, according to the planner.
Interest rates could also rise, further increasing the cost of the line of credit.
“The redirection of the monthly surplus would allow the COL to be reimbursed in 12 months”, explains the planner. To pay it off sooner, they could sell the $32,000 in shares they have in their taxable account, which has a large capital loss. “They could realize the loss and direct the sale proceeds to the LOC.”
Alternatively, it could be used to maximize their TFSA, but they should be aware of the superficial loss rule, he says.
“Since they have a loss, they shouldn’t just transfer the shares in kind to a TFSA. They should sell and contribute the money to the TFSA,” says Sears. “When the TFSA contribution is made, they should not redeem the shares within 30 days or the loss would be considered a superficial loss.” There would be no problem if they chose to invest the funds in something else.
Once the mortgages and line of credit were paid off, Barry and Beth could redirect the amount they were paying ($1,300 on the mortgages and $5,000 on the line of credit) plus their monthly surplus of about $4,600, toward retirement savings starting in March 2025, Mr Sears said. “The goal of retiring at 62 is only 95% achieved,” says the planner. To fully meet their goal, they would need to save an additional $3,700 per month from 2025 to 2032.
To summarize the savings plan, Barry and Beth are directing $9,600 to the line of credit by July 2023. Starting in August 2024, they are directing the $9,600 to risk-free investments such as GICs or to mortgages. If they set aside the funds 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 per month that went to the mortgages and the $9,600 that went to the retirement savings line of credit instead.
“Another way to look at it is that they need about $2,947,000 in investable assets to maintain their retirement spending goal,” Sears said. In the forecast above, their maximum sustainable spending is $11,500 per month, which is very close to their monthly retirement spending goal.
The projections assume that Beth and Barry will retire in January 2033, begin receiving Canada Pension Plan and Old Age Security benefits at age 65, and live to age 95. Barry will receive a pension of $5,090 per month starting at age 62. their investments average 5.45% and inflation 2.2%.
Beth contributes 4% of her salary to her defined contribution pension plan with 100% matching from the employer.
A lower rate of return would change things a bit. “If we lowered the expected rate of return by one percentage point at retirement, they would only reach 85% of their spending goal,” says Sears. “The maximum sustainable expenses would be $10,000 per month. Instead of $2,947,000 to meet their spending goal of $12,000 per month, they would need $3.25 million in investment assets.
One item that isn’t factored in is Beth’s annual discretionary bonuses, which they prefer not to rely on in their planning, Sears notes.
“If the bonuses were paid annually and added to savings, it would make up for the shortfall needed to meet the retirement expense target.”
After the debt is paid off and the savings withdrawn, Barry and Beth’s current lifestyle expenses will be about $8,275 per month, which is about 70% of their retirement spending goal, Sears notes.
Status of customers
The people: Barry and Beth, both 52, and their children, 19 and 21
The problem: Are they saving enough to retire at age 62 on $12,000 a month?
The plan: Pay down the line of credit, then the mortgages and redirect the cash flow and any excess to his long-term retirement savings. If they’re a bit short, saving whatever bonuses Beth might get would cause them to float.
Gain : A clear path to the retirement goals they seek.
Net monthly income: $24,715
Assets: Shares $32,000; residence $2 million; his TFSA of $53,000; his TFSA of $43,000; his RRSP $457,000; his RRSP $112,000; his locked-in retirement account from his former employer $202,000; his 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 expenses: Mortgage $1,300; property tax $675; water, sewer, garbage $150; home insurance $175; electricity, heating $350; security $35; maintenance $300; garden $100; transportation $875; groceries $1,000; university tuition $1,500; clothing $500; line of credit $5,000; gifts, charity $850; vacation, travel $250; meals, beverages, entertainment $1,100; personal care $100; pets $200; sports, hobbies $200; doctors, dentists, pharmacy $125; health, dental $505; life insurance $785; communications $500; RRSP $500; TFSA $1,000; pension plan contributions $1,980. Total: $20,055. Excess $4,660
Passives: Mortgage of $72,995 at 1.62%; mortgage of $78,185 at 1.67%; line of credit of $115,000 at 4.2%. Total: $266,180
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