Luna, 68, hopes to retire in January and maintain her lifestyle.CHAD HIPOLITO/The Globe and Mail
Luna will be 68 this year and is worrying whether she has enough money to retire from her government job without having to sell her home.
She earns about $83,000 a year and will be entitled to a defined benefit pension of $31,270 a year, indexed to inflation, when she hangs up her hat.
She has a rental suite in her B.C. home that covers the cost of her $240,000 variable-rate mortgage. She also has some savings, although her portfolio “is probably smaller now with the shift in financial markets,” Luna writes in an e-mail. “With the cost of everything going up, I wonder if I should wait longer to retire,” she writes. “I do not want to be scraping pennies.” She has two adult children.
Luna hopes to retire in January and maintain her lifestyle. She’ll also need a new car soon. “Do I need to sell the house and pay off the mortgage to retire with a similar lifestyle?”
We asked Andrea Thompson, a certified financial planner (CFP) and founder of Modern Cents, an advice-only financial planning firm based in Mississauga, to look at Luna’s situation.
What the expert says
Luna’s postretirement lifestyle will look slightly different from her current lifestyle, Ms. Thompson says. Her monthly savings amount to $1,738, which will disappear upon retirement. She also plans to stop the extra mortgage payments of $400 a month. As well, she anticipates having higher paramedical, dental and drug costs because her group plan will only cover $500 a year upon retirement. Her total needs will be $54,265 a year net of tax, or $4,522 a month.
One factor that may change her lifestyle costs is the mortgage payment, the planner says. Luna is on a variable adjustable mortgage, and her payments have increased significantly this year. If interest rates increase again, Luna will have to make allowance for higher out-of-pocket mortgage interest costs.
Currently, her variable rate is 4.7 per cent. Her mortgage renews in 2025, at which time there will be about $197,000 remaining.
Luna’s public service pension plan will pay $2,606 a month, indexed to inflation. She will also qualify for 92 per cent of the Canada Pension Plan benefits and full Old Age Security benefits. If she elects to begin all pensions in January, 2023, she will receive $4,804 a month pretax, the planner says. As well, she will collect rental income of $1,607 a month, bringing her pretax income to $6,411.
Luna’s average tax rate during retirement will be 19 per cent. Based on this calculation, she ought to have taxes withheld at source for all of her pensions (of 20 per cent), which would leave her with $3,843 a month from her pensions, plus her rental income of $1,607. Her total monthly inflow will be $5,450, which is greater than her total lifestyle needs of $4,522 a month.
This leaves her with a monthly surplus of $928, Ms. Thompson says. This could be allocated to any increase in her mortgage costs.
“Given Luna’s concern around inflation, she will be happy to know that all of her pension sources will be adjusted to inflation,” the planner says. An inflation adjustment may not fully cover her perceived increased lifestyle costs, however. “Given her projected surplus of $928, this may help to ease the burden of increased living expenses over and above the inflation adjustment her pensions provide.”
Any unspent monthly surplus ought to be allocated to build up Luna’s tax-free savings account during retirement to save for travel, emergency expenditures, and her future car purchase.
Deferring her CPP and OAS benefits to a later date would have little effect on Luna’s ability to meet her lifestyle goals longer term, the planner says. By waiting until age 70, Luna can increase the value of her CPP and OAS pensions by 0.7 per cent a month and 0.6 per cent a month, respectively, over what she would get at age 68. “The drawback of doing this is that Luna would be depleting her TFSA savings immediately upon retirement to sustain her lifestyle.” She had planned to use the money for a car purchase. If Luna expects to live longer than average, the benefits of deferred CPP and OAS pensions become more valuable, the planner says.
Luna’s registered retirement savings plan portfolio has not performed well as of late, and is composed mainly of high-growth mutual funds. There is no cash in the account and the only fixed income component is bundled into a few balanced funds. Overall, Luna’s RRSP has an average weighted management expense ratio of 2.29 per cent, and some of the funds still have deferred sales charges, so there is a penalty to sell them. “There have been no efforts made to orient her portfolio for a retirement decumulation strategy,” Ms. Thompson says. Luna’s portfolio generates a measly 0.39 per cent annual yield.
“This is not congruent with a preretirement or retirement income strategy, as it is mainly focused on growth and not income,” Ms. Thompson says. “Based on Luna’s needs, she ought to have a more income-oriented portfolio with greater downside protection.” She has seen the unfortunate repercussions of the high-growth strategy in 2022, the planner says.
To let the portfolio recover some of its losses and to get it reoriented for retirement income, Luna ought to defer taking RRIF income until age 72. Taxpayers must convert their RRSPs to registered retirement income funds at age 71 and begin drawing mandatory minimums in the year they turn 72. Once she begins taking her minimum RRIF income, she can add it to her TFSA. “This way, she can continue to boost her liquid savings available for emergencies, health care spending or other necessities outside of her regular lifestyle spending,” Ms. Thompson says.
Another option that Luna could consider is a life annuity. “An annuity is, in essence, the creation of your own defined benefit pension plan, using the existing assets in your RRIF or RRSP,” the planner says. Since Luna is not concerned about leaving an estate, a life annuity would be suitable because it would provide a steady, reliable income upon retirement without having to worry about stock market fluctuations. “Since interest rates have risen, considering an annuity at this stage of the economic cycle could be more lucrative for a nervous investor.” However, the downside is that Luna would have limited liquid assets remaining, which could be problematic if she ever required a large, lump sum of cash from her RRIF.
Since Luna’s pensions and rental income will fully cover her lifestyle needs, there is no specific rate of return needed from her investment portfolio. Ms. Thompson recommends that Luna set up a home equity line of credit as an emergency fund prior to retirement so she can access equity in her home without having to get a reverse mortgage or sell her home.
In the future, if Luna does decide to sell her home, there will be tax implications since the property has appreciated in value, and she has rented out half of it since Day 1. Her portion of the house would qualify for the principal residence exemption. “If she sells her home today, the capital gains tax owing on the rental portion of the home would be about $50,000,” Ms. Thompson says.
Client situation
The person: Luna, age 68
The problem: Can she retire next year and keep her home, without having to downsize?
The plan: Retire in January with a government pension plan. Continue to rent out a portion of the home to generate rental income and offset mortgage costs.
The payoff: A comfortable retirement.
Monthly net income: $6,488 (including net rental income).
Assets: RRSPs $153,000; TFSA $30,000; bank savings $5,000; estimated present value of defined benefit pension plan $469,000; House $900,000. Total: $1.56-million
Monthly outlays: Mortgage, property taxes, property insurance, utilities and repairs $2,155; extra mortgage payments $400; transportation, gas, car insurance, maintenance, parking $190; groceries $300; clothing/dry cleaning $165; charitable $10; phone, internet, cable $240; vacation $165; gifts $65; entertainment, dining out, hobbies, personal care $400; health care expenses $540; RRSP and TFSA contributions $1,165; pension plan contributions $570. Total: $6,365
Liabilities: Mortgage $237,000, no-interest loan $5,935. Total: $242,935
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