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Tom and Charlene will depend on savings to retire, says expert

Publication date:

Jan 20, 2022 • Jan 20, 2022 • Read 5 minutes • Join the conversation Early retirement means that if inflation picks up, corporate pensions lose purchasing power and interest rates tend to rise. Early retirement means that if inflation picks up, corporate pensions lose purchasing power and interest rates tend to rise.

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A couple we’ll call Tom and Charlene, both 40, live in BC with their seven-year-old son Sam. They bring home $13,179 a month from their high-tech jobs plus additional income from a rental property. Tom has a fixed pension, but at 55, which is their goal, would mean a reduction in the annual benefit. Their question is when to retire: the sooner they retire, the longer they have to bear the risk of rising living costs eroding their purchasing power. Because a pension can last 35 years, that risk is considerable.

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Retirement would not be the only income stream at risk from early retirement. Retiring can also reduce the income needed to generate CPP benefits by about 15 to 20 percent. That’s on top of the 36 percent reduction that would come if you started CPP at 60.

The financial question is, can they make their plan work and reach their goal of $6,000 in minimum monthly income?

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Email andrew.allentuck@gmail.com for a free Family Finance analysis.

Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, BC, to work with Tom and Charlene.

Before moving on, the couple wants to make sure they’ve taken care of Sam for post-secondary education. He has $30,000 in his RESP. The parents contribute $208 per month and receive the lower of 20 percent or $500 per year of the Canada Education Savings Grant up to a limit of $7,200 per beneficiary. Assuming three percent annual growth in rising balances, Sam will have $62,500 by age 17, when he is ready for post-secondary education. That is enough for a four-year education if he lives at home.

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The financial basis for retirement

In order for retirement to work with a start ten years before the usual start of CPP, OAS and occupational pensions, Tom and Charlene will be dependent on savings.

They have $227,000 in GICs and $10,000 in cash that they can use to add to RRSPs to lower taxes and perhaps reduce their two major debts — $210,000 on their home and $638,000 on their rent.

For now, the couple’s net worth, $2,142,000, is excellent for their age, Moran explains. They have enough savings to create tax relief opportunities. Each partner has an unused RRSP room: $125,000 for Tom and $78,000 for Charlene. They should take $67,000 from their GIC and put it into Tom’s RRSP to cut his taxes. They can use the remaining $160,000 in cash to pay off their personal mortgage from $210,000 to just $50,000. Rewrite the mortgage over 10 years to a small payment of $462 per month and shift $2,186 per month from the old amount of $2,648 to the RRSP.

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Retirement Mathematics

Tom’s work pensions will pay him $59,724 a year if he works until he turns 62, but every year before that will lead to cuts, both due to the fact that he has fewer years of work credit and the earlier start date. At 55, he would qualify for $25,060 a year, less than half the level of 62.

The current maximum payout for CPP is $14,445 per year. The loss caused by quitting at age 55, due to a reduction in the number of years worked, an important part of the CPP formula, would be 15 percent for Tom and 30 percent for Charlene. That lowers their base 65-year CPP payments to $12,278 and $10,112 respectively.

Each partner can take the full Old Age Security, currently $7,707 per year, at 65.

The pair’s RRSPs have a current total of $140,000. A one-time contribution of $67,000 plus $2,186 per month, growing 3% after inflation for 15 years until retirement, would become $825,023 at age 55. If that amount is spent over the next 35 years, it would yield $37,278 pre-tax annual income, all in $2022.

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The couple’s $168,000 TFSA balance plus $12,000 annual contributions growing three percent over inflation would become $491,620 at retirement 15 years from now. That capital, spent over the next 35 years to age 90, would yield $22,213 per year, exhausting all income and capital.

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Their $1.2 million rent is a dilemma. It earns a rent of $5,000 per month. They have equity of $562,000 and owe $638,000. Property taxes, insurance and the interest on the mortgage cost them $18,311 a year. Their net rental income, $60,000 less in costs, makes for a healthy $41,689 a year. They now have a seven percent return on equity, which is excellent. If they are able to fully pay off the rental mortgage for 55 years – it will be close – they will have no mortgage interest and thus $50,812 annual net rent.

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At age 55, the couple would have $37,278 from RRSPs, $22,213 from TFSAs and $50,812 rent with mortgage paid and Tom’s $25,060 pension. That’s a total of $135,253. Assuming a split of qualifying income, no tax on TFSA income, and 19 percent average tax, with TFSA cash flow restored, they would have $9,480 per month to spend. At age 65, they were able to add $12,712 and $10,112 from CPP and $7,707 per person from OAS, totaling $173,450. With splits, no tax on TFSA cash flow, and 20 percent average tax, they would have $11,935 per month to spend. Their target minimum retirement income, $6,000 per month, would be met and sustainable. Without home or rent mortgage payments and without RESP or TFSA savings, their costs would drop by $7,656 to $5,523 per month.

risks

Early retirement means that if inflation picks up, corporate pensions lose purchasing power and interest rates tend to rise. We cannot predict inflation, but the risk to income is clear. If Tom worked until 62, he could commit a much larger annual retirement payment and reduce those inflation risks.

Retirement stars: 4 **** out of 5

Email andrew.allentuck@gmail.com for a free Family Finance analysis.

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This post The specter of inflation adds to the risk of early retirement for this young BC couple

was original published at “https://financialpost.com/personal-finance/family-finance/spectre-of-inflation-adds-to-early-retirement-risk-for-this-young-b-c-couple”