via The Globe and Mail | October 28, 2015
Lana and Larry are in their late 40s with two children, ages eight and 12. He brings in $107,000 a year, she’s a stay-at-home mom.
Recently, they left Toronto for a more expensive home in the country, “which will significantly cut into our ability to save,” Larry writes in an e-mail. Not only do they have a mortgage now, but their operating costs are much higher: “Double the property insurance, double the property tax, higher commuting costs … and a much greater proportion of our net worth is in the house, which also makes me nervous,” Larry writes. “Has the grander home screwed our retirement plans?”
Short-term, they want to renovate the kitchen, do some major landscaping and “enjoy life with our kids,” he says. They’d also like to travel a bit before the children grow up. “However, if an extra $5,000 per year in travel expenses means I have to work until I drop dead, then it doesn’t sound so appealing.”
Longer term, they want to help their children through university and save enough to maintain their lifestyle when Larry hangs up his hat. He’s resigned to the idea of working until age 65, “but I would like to stop sooner. It seems to me that I can’t afford to!”
We asked Matthew Ardrey, vice-president of T.E. Wealth in Toronto, to look at Larry and Lana’s situation.
What the expert says
Larry and Lana may be feeling pinched at the moment, but they are not in bad financial shape, Mr. Ardrey says. They took out a $100,000 mortgage to buy the larger home, which they are paying off at the rate of $6,360 a year. The mortgage rate – now 2.59 per cent – is estimated to rise to 5 per cent in five years and remain at that level for the duration. So if Larry retires in 2033 at age 65, they will still be making mortgage payments.
This is not a big problem. “Though being debt-free is a cornerstone of financial independence, their debt owing at Larry’s retirement will only be about $30,000,” Mr. Ardrey says. Their $530-a-month payments “are not that onerous.”
They have no room in their budget for the kitchen renovation and landscaping, so the planner assumes these renovations ($40,000) will be funded by dipping into their non-registered savings.
When they retire, Larry and Lana plan to spend $50,000 (after tax) in today’s dollars – very close to what they are spending today once debt repayment and savings are removed, Mr. Ardrey notes. They’d like to have another $10,000 a year for travel, which the planner has included in his plan to Larry’s age 80. Their projected spending is forecast to rise in line with inflation, which the planner estimates at 2 per cent a year.
Larry is saving $6,480 a year in his defined-contribution pension plan, which his employer matches dollar-for-dollar. He also contributes $6,480 a year to Lana’s spousal RRSP. In his plan, Mr. Ardrey assumes an average annual return on investment of 5 per cent (interest, dividends and capital gains) and a lifespan of 90 years. He assumes Larry begins collecting maximum Canada Pension Plan benefits at age 65. Lana will get 50 per cent of the maximum. He assumes their Old Age Security Pension benefits will be clawed back.
“Based on these assumptions, Larry and Lana will be able to meet their retirement goal comfortably,” the planner concludes. They would leave an estate of more than $2.5-million.
If they decided to spend all of their savings, leaving only their home and personal effects for their children, they could spend $78,000 a year in retirement in addition to the mortgage payments and travel expenses, the planner says. Alternatively, Larry could retire earlier. If he retired at age 60, their spending would be $57,000 a year instead of $78,000.
Another option would be for the couple to draw on their savings to pay off the mortgage now, Mr. Ardrey says. They’d have about $100,000 left (non-registered stock investments and Lana’s tax-free savings account) after paying for the renovations. They should review the capital-gains implications of selling stock, as well as any penalties for prepaying the mortgage.
“If they chose to pay off their debt now, leaving all other assumptions constant, they could spend $71,000 a year if Larry retired at age 65 and $54,000 a year if he quit at age 60, Mr. Ardrey says. While this lowers their future spending, it would give them access to more income now. He also recommends they diversify their investments, which are mainly in Canadian stocks, and consider using low-cost investment pools or exchange-traded funds.
The people: Larry, 46, Lana, 47, and their two children.
The problem: Has moving to an expensive home in the country jeopardized their financial security?
The plan: Cash in some savings to pay for the renovations and consider drawing on the remaining savings to pay off the mortgage now. Diversify investments more broadly and consider low-cost investment pools or exchange-traded funds.
The payoff: The ability to step back and realize that Larry is worrying needlessly and that their retirement goals are achievable.
Monthly net income: $6,647
Assets: Cash $10,000; stocks $100,000; her tax-free savings account $40,000; his RRSP $120,000; her RRSP $300,000; market value of his employer pension plan $300,000; children’s registered education savings plan $85,000; home $850,000. Total: $1.8-million
Monthly disbursements: Mortgage $530; property tax $550; water, sewer, garbage $100; home insurance $150; heat, hydro $200; maintenance $100; garden $100; transportation $800; grocery store $1,000; clothing $100; gifts, charitable $100; vacation, travel $200; other discretionary $327; grooming $50; dining out $100; pets $60; sports, hobbies $250; dentists, $100; health, dental insurance $50; disability insurance $90; telephone, TV, Internet $195; RRSP $540; RESP $415; his pension plan contributions $540. Total: $6,647
Liabilities: Mortgage $100,000 at 2.59 per cent