Situation: Couple’s wealth is mostly in their home and much retirement income will be from job plans
Solution: Keep the house, sell TFSA and non-registered assets to pay off mortgage
In British Columbia, a couple we’ll call Victor, who is 61, and Betsy, who is 56, live in a townhouse. Each is a manager in a large organization. Their issue is peculiar to folks who work for companies that have defined benefit pensions and live in hot urban real estate markets. The DB plans limit RRSP room to what is left after the employer makes contributions and forces employees to contribute. Sixty per cent wealth is in their home and a very large part of their retirement income will be from their job pensions. They see themselves locked into retirement plans and worry about keeping their home. As we’ll see, however, their financial futures are secure.
”Can we keep the house or should we downsize?” they ask.
Much of their wealth is locked up in their home and estimated in the commuted value of their company pensions. Commuted value is the capital required to pay the pensions. They cannot get to it unless they cash out — a process that would deprive them of professional asset management, guaranteed income and complicate their tax planning.
Family Finance asked Graeme Egan, head of CastleBay Wealth Management in Vancouver, to work with the couple to find ways to estimate and manage their retirement income.
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DB pensions limit RRSP contributions
Victor and Betsy bring home $8,136 per month. That is 68 per cent of their combined $12,000 monthly pay. The 32 per cent cut reflects tax withholding and large deductions for various job benefits including company pension contributions. Their employer does most of their pension saving and much of their retirement planning for them, leaving relatively little space to build up RRSPs. The pension adjustment, the PA, limits what they can put into their RRSPs. It is a regulatory limit imposed on personal RRSP contributions.
As a result, their RRSP savings are just $386,700. They have other savings including $72,200 in TFSAs and $247,500 in a taxable account. Their own pensions are their main source of retirement income.
Victor and Betsy want to retire as soon as possible provided they can be sure of having $6,000 per month for spending. Assuming that Victor retires very soon, say next year, Betsy would get $3,136 per month from her company plan including an $866 per month bridge which stops at 65. Victor would get $3,578 per month from his plan including a $1,059 bridge to 65. At 65, Betsy would get $998 per month from the Canada Pension Plan and Victor about $1,050 per month. CPP payouts are reduced by 7.2 per cent per year for each year taken before 65. Each would receive $601 per month from Old Age Security at 65.
Adding it up, the couple’s pensions would provide $80,568 per year to 65 before 13 per cent average tax. That would leave them with $5,850 per month after tax, which they could boost to their target $6,000 monthly income after tax by small RRSP withdrawals of $150 per month or just by cutting their spending by a similar amount. Yet they face budget pressures within five years. Their $331,000 home mortgage with a 2.89 per cent interest rate is certain to be rolled into a higher rate. They can pay more or maintain payments with a longer amortization, though that is not wise in retirement.
To sell or not to sell
Downsizing their residence is not necessarily a good plan, Egan says, for the sale they have in mind would net them only about $725,000 after paying off their $331,000 mortgage, penalties and 5 per cent selling costs. In urban areas of the lower mainland, that would not buy a lot of housing. In sum, there is little to be gained, Egan says.
Rather than sell their present residence and trade down, the couple could pay down the mortgage at 20 per cent per year without penalty. They could use money available in Betsy’s non-registered account with a balance of $247,500 and add $72,200 of TFSA assets for a total of $319,700. That would allow a payment of about $64,000 each year for about five years to eliminate the mortgage, the balance of which would have declined in each successive year. They would keep their house with this plan.
When both partners are 65, income will rise. Their defined benefit pension plan payments would decline. Victor will receive $2,519 per month and, later, Betsy $2,270 per month. Making up the difference, Victor would get an estimated $1,050 from CPP, Betsy $866. Each would receive $601 per month in Old Age Pension benefits.
Assuming the couple preserves $385,700 of RRSP assets, then two more years of RRSP contributions at $8,400 per year with growth at 3 per cent after inflation would leave their RRSPs with $426,240. If that sum is paid out to exhaust all income and capital over the next 25 years, it would generate $24,475 per year or $2,040 per month.
They would have total pre-tax income of $9,947 per month. That’s $119,364 per year. If eligible pension income is split and pension and age credits applied, the couple would pay tax at an average rate of 16 per cent and thus have about $8,355 per month to spend. They would be far ahead of their target $6,000 per month after tax retirement budget with no further compromises.
We’ve compressed time to show how incomes will rise over time in retirement — in reality, there is a five year difference in ages. With these numbers, their discretionary spending could rise, for the $1,811 monthly mortgage would be paid off, there would be no more $1,000 per month TFSA and RRSP savings. That would amount to an impressive $33,732 annual addition to funds for spending and it is effectively after tax. Frugality early in life pays a dividend later in life, the planner notes.
They can they use the B.C. Seniors Property Tax Deferral Program to save about $5,160 yearly after a lending cost usually no more than one per cent until they sell and repay the loan. “They have adequate savings and a strong pension base. They will have funds above their estimates for such things as home repairs or new car. “These folks should be fine,” Egan concludes.