Leah, 67, is a professional, earning $175,000 a year. She is still working to build up their savings and pay off the remaining mortgage – about $92,800 – on her and Mark's small-town Southern Ontario home.Nick Iwanyshyn/The Globe and Mail
Mark and Leah have had some setbacks over the years.
Midway through his professional career, Mark decided to go back to university to get his PhD. Before he could practise in his new field, he suffered a life-threatening illness.
Now, at the age of 69, Mark is retired.
Leah, 67, is also a professional, earning $175,000 a year. She is still working to build up their savings and pay off the remaining mortgage – about $92,800 – on their small-town Southern Ontario home. They also have an $8,500 line of credit taken out to pay for a new roof.
Leah is hoping to finally retire in two years. When she does, she will be entitled to defined benefit pensions, two that are indexed to inflation, from her current and previous employers. The three pensions add up to $48,000 a year.
Mark and Leah have two adult children who are financially independent.
Leah and Mark’s main questions are three: Should they tap Leah’s registered retirement savings plan to pay off the remaining mortgage? Should she withdraw the allowable 50 per cent from her locked-in retirement accounts once they are converted to life income funds? Most important, how much can they sustainably spend in retirement?
We asked Hannah McVean, a certified financial planner at Objective Financial Partners Inc. in Markham, Ont., to look at Mark and Leah’s situation.
What the expert says
First, the mortgage. The mortgage balance is projected to be $72,000 when it comes up for renewal in December, 2025, Ms. McVean says. “I’ve assumed that the mortgage payments are regular biweekly, although Leah has stated she is using a double-up feature,” the planner says. Her planning software doesn’t model a double-up feature.
To estimate what the couple’s mortgage rate might be at renewal, the planner used FP Canada’s guideline borrowing rate of 4.4 per cent. “Assuming the same biweekly payment, the mortgage would be repaid by July, 2030.”
Paying it down now by drawing on registered funds would come with a big tax hit.
With employment income of $175,000 a year, Leah is in the 44.97- to 48.29-per-cent marginal tax bracket, depending on her annual registered pension plan deduction, Ms. McVean says. Leah is collecting Canada Pension Plan benefits of $14,500 a year, which she contributes directly to an RRSP, offsetting the income. “Any withdrawals from her RRSPs or locked-in retirement accounts – for example, to pay off the mortgage – would increase her income each year and would be taxed at her marginal tax rate,” the planner says.
To illustrate, she looks at how a lump-sum payment might work. “If, for example, the original mortgage amount was $200,000, then they might be able to prepay $20,000 each year without penalty,” the planner says. “To make a lump-sum mortgage payment of $20,000, Leah would need to withdraw at least $28,571 from her RRSP.” RRSP withdrawals are subject to a withholding tax. For amounts withdrawn over $15,000, the plan provider must withhold 30 per cent in tax. To net $20,000 in the bank, Leah would need to take out at least $28,571 ($28,571 x 70 per cent = $20,000), plus a withdrawal fee, the planner says.
This figure would be included with her employment income on her income-tax return, giving her a total income of $203,600. “All the new income would be taxed at 48.29 per cent, but she would only have had 30 per cent in tax withheld, so she might owe up to $5,225 in additional tax when it’s time to file her tax return.”
Leah could offset this by taking out more money. She’d still be in the same tax bracket by withdrawing the larger amount, but the withdrawal would represent “a large chunk of her total RRSP/LIRA assets, leaving her in a difficult position as she prepares for retirement,” Ms. McVean says.
“RRSPs and LIRAs are generally best contributed to in high-income years and withdrawn in low-income years, ideally in retirement,” the planner says. “If you need withdrawals during your working years, or if you take a big chunk in a single year in retirement [such as a 50-per-cent unlocking after a LIRA is converted to a LIF], you might end up paying more tax than you hoped to by deferring the tax in your working years,” Ms. McVean says. “For Leah, I’d question whether depleting her investment assets by withdrawing either from her RRSPs or LIRAs and paying the extra income tax is worthwhile.”
She compares the estimated future mortgage interest rate with projected rates of return after fees on investments held in Leah’s RRSPs and LIRAs. “Leah is invested mostly in bank-managed balanced mutual funds, and I estimate the prefee return would be 5.15 per cent. The fee on these mutual funds is 2.10 per cent, so the after-fee expected return might be 3.05 per cent,” she notes. If Leah could reduce her investment fees, she could possibly achieve a comparable after-fee return to her future mortgage interest rate. “I’m hesitant to suggest this, but a robo-adviser fee of 0.70 per cent including product would bring the projected after-fee return to 4.45 per cent,” Ms. McVean says.
Leah’s asset allocation is 35-per-cent fixed income, 33-per-cent Canadian equities, 12-per-cent U.S. equities, 16-per-cent international equities and 4-per-cent other.
“Also, once her line of credit is repaid, Leah can funnel those dollars toward the mortgage and pay it off earlier.”
Assuming Leah retires in 2026, she will be 70 that year and can start Old Age Security benefits at that time. “Taking OAS any earlier would not be recommended because with her high income, up to 100 per cent of her benefit could be clawed back.”
So how much can they afford to spend?
Assuming reduced investment fees, OAS at 70, and a 25-year retirement with all other factors remaining constant (returns, portfolio contributions, no market crashes, etc.), their total retirement lifestyle spending ability would be $97,000 a year after taxes, in addition to the funds required to pay down their remaining mortgage. “This is a bit less than their current lifestyle spending so they may have to find some areas to cut back,” Ms. McVean says. That’s assuming Leah does not draw on her registered funds to pay the mortgage off earlier.
A breakdown of their cash flow in the first full year of retirement, 2027, with inflation, would be as follows: pension $50,130, their CPP $25,735, their OAS $21,400; RRSP/RRIF withdrawals $46,080; tax refunds $390, for a total of $143,735. Against this would be lifestyle expenses of $102,650, debt repayment of $22,490 and income tax of $18,595, for a total of $143,735.
Client situation
The people: Mark, 69, and Leah, 67.
The problem: Should she tap her registered savings to pay off the mortgage? How much can they afford to spend in retirement? When should she take OAS?
The plan: Cashing in RRSPs or LIRAs to pay off the mortgage would result in a big income-tax hit. Better to let the mortgage run. Defer OAS to 70. Take steps to lower investment fees.
The payoff: A sustainable retirement income of $97,000 a year after tax.
Monthly net income: $14,830.
Assets: Cash $15,000; her RRSP $226,000; her two LIRAs $103,000; her second RRSP $32,000; residence $800,000. Total: $1.2-million.
Estimated present value of her three defined benefit pension plans: $758,000. This is what someone with no pension would have to save to generate the same income.
Monthly outlays: Mortgage (double up) $1,430; property tax $400; water, sewer, garbage $160; home insurance $80; electricity $200; heating $150; maintenance, garden $165; transportation $275; line of credit $1,450; groceries $800; clothing $415; dry cleaning $100; gifts, charity $1,000; vacation, travel $235; other discretionary $200; dining, drinks, entertainment $500; personal care $20; pets $335; subscriptions $100; other personal $200; doctors, dentists $250; drugstore $70; term to 85 life insurance $265; phones, TV, internet $315; RRSP $1,210; other saving $1,000; pension plan contributions $1,665. Total: $12,990.
Liabilities: Mortgage $92,800 at 1.79 per cent; line of credit $8,500 at 3.14 per cent. Total: $101,300.
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