Situation: Couple with two children needs to manage debt to optimize retirement income
Solution: Follow priorities, save for RESPs and build wealth in three decades to retirement
In Ontario, a couple we’ll call Mel, 37, and Helen, 40, are raising two children ages four and one. They bring home $10,167 per month and add $275 from the Canada Child Benefit. At this stage of family life, they have a $750,000 house, $328,000 in RRSPs, $13,200 in RESPs and two cars, but they are also saddled with a $191,387 mortgage, as well as a $28,000 student loan and a car loan.
Both work as researchers for technology companies, neither of which has a defined-benefit pension plan. In terms of retirement, after receiving matching RRSP contributions from their employers, they will be substantially on their own.
“We would like to optimize our mix of savings and debt payments,” Mel explains. “Our goal is to have $90,000 in annual pre-tax income when we retire in twenty years.”
(Email firstname.lastname@example.org for a free Family Finance analysis.)
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Mel and Helen. “It is a question of balancing priorities with opportunities to cut costs. So that is what we are going to do.”
Helen has $28,000 left on her student loan, on which she is paying 6.34 per cent interest. Interest is tax-deductible, but even after the 20 per cent non-refundable tax credit, the borrowing cost is 5.1 per cent. They could save money by doing a blend-and-extend loan with their bank, adding the student loan to their home mortgage. They would then add the former loan payment, $150 per month, to the home mortgage payment, $1,770 monthly.
The current mortgage loan rate is 3.14 per cent for 11 years, so the adjustment would save them 1.96 per cent. That’s a 30 per cent cut in the student loan interest rate. Even with the additional cost of the student loan, their mortgage would be history by Mel’s age 49.
Mel and Helen have $13,200 in the family RESP. They are adding $350 per month. They should bump that up to $417 per month, $5,000 per year, to attract the maximum Canada Education Savings Grant of the lesser of $500 or 20 per cent of contributions. If they do that, they will be able to hit the cut-off for the CESG of $7,200 per child when each is about 14 and have about $75,000 each for post-secondary studies. That would cover tuition, books and some accommodation at most universities in Ontario. Funds not spent might pay for grad studies.
For retirement, neither Mel nor Helen will have a company pension. With their current employment, they will have the opportunity to grow present balances of $164,000 each. Helen can add $5,200 per year to her plan based on $2,600 from her pay and an equal match from the employer. Mel puts in $8,632 plus a $3,960 match from the employer, total $12,592 per year. The annual contributions add up to $17,792.
If the $17,792 contribution rate is maintained for 20 years to Helen’s age 60, and added to the present balance of $328,000, it will become $1,070,500 assuming a three per cent growth rate after inflation. That sum, still growing at three per cent after inflation, and spent over the following 35 years to Helen’s age 95 and Mel’s age 92, would support taxable income of $48,400 in 2020 dollars.
If Mel and Helen extend their contribution period by five years to their ages 65 and 62, they could accumulate $1,335,440 to provide income of $68,133 per year for the following 30 years.
Mel and Helen have $9,200 combined in their Tax-Free Savings Accounts. For now, they should suspend contributions and use the money for the more immediate needs of their kids’ RESP accounts, Moran suggests. The present mortgage has about nine years to go, so the deferral of TFSA contributions would end in 2028. The couple’s current TFSA balances are $4,600 each. Adjusted for growth in previous contributions, Mel and Helen would each have $112,000 TFSA space to fill plus additional space growing at $6,000 per year per person.
Once they are mortgage-free, there should, in theory, be $1,770 per month available for TFSA savings. If that is saved for nine years to Helen’s age 60 at three per cent after inflation, they could accumulate $234,256. That sum could provide tax-free income of $10,884 indexed to inflation for the following 35 years to her age 95. Another five years with annual contributions at $6,000 per person would lift TFSAs to $315,366 and raise payouts for the following 30 years payouts to $16,100 per year.
If Mel and Helen retire at Helen’s age 60, then their income could consist of $48,400 in RRSP payouts and $10,884 from their TFSAs for total income of $59,284. They would be far from their $90,000 annual pre-tax retirement income goal. At Helen’s age 65, they would be able to add her $7,362 Old Age Security and her estimated $12,470 Canada Pension Plan benefit for total, pre-tax income of $79,116 before tax. When Mel is 65, income would rise with his $7,362 OAS and his estimated $12,470 CPP to $98,948. They would be meeting their retirement income target.
If the couple works until Helen is 65, their RRSP income would rise to $68,133, their TFSA income to $16,100 annually plus her $12,470 CPP and $7,362 OAS for total income of $104,065, well over their $90,000 pre-tax retirement income target. Three years later, when Mel is 65, their annual income would rise with his estimated $12,470 CPP benefit and his $7,362 OAS benefit to a total of $123,897.
The value of patience
These estimates assume that the couple will not build non-registered savings. Indeed, they probably will, but the variables including when they can start and how long they can sustain them are too speculative to measure, Moran notes.
These projections suggest retirement at Helen’s age 60 would be premature, Moran says. They would have to draw down more than $30,000 per year from some accounts to attain their $90,000-a-year goal. Working to 65 is the sound path to retirement with no need to dip into capital for five years. That stabilizes their finances.
“This plan has time to get debts paid and savings built,” Moran concludes.
Retirement stars: Four **** out of five
Email email@example.com for a free Family Finance analysis.