Walter and Nadia are wondering if they should pay off the $330,000 variable-rate mortgage on their $1.1-million southwestern Ontario house.Carlos Osorio/The Globe and Mail
Walter is 57, Nadia is 54. They have three children who range in age from 21 to 36, with the youngest still living at home.
Walter earns more than $160,000 a year in government and Nadia more than $90,000 a year in health care. They want to retire soon mainly because they can – both have defined benefit workplace pension plans, partly indexed to inflation.
When they retire, they plan to spend a couple of months each year in Europe.
Short term, they wonder if they should pay off the $330,000 variable-rate mortgage on their $1.1-million southwestern Ontario house. They also plan to start giving each of their children an annual Christmas gift of $2,500.
“Will we need to draw from our investments – other than mandatory RRSP/RRIF withdrawals – to maintain our lifestyle?” Walter asks in an e-mail. Their retirement spending goal is $120,000 a year after tax.
We asked Matthew Sears, a financial planner and portfolio manager at CWB Wealth in Toronto, to look at Walter and Nadia’s situation. Mr. Sears holds the certified financial planner (CFP) and chartered financial analyst (CFA) designations.
What the expert says
Meeting their retirement goal is achievable, with up to 115-per-cent coverage of their desired spending throughout retirement, Mr. Sears says. That means they could afford to spend as much as $138,000 a year from the time they retire to age 95. But they must pay off the mortgage immediately to achieve the 115-per-cent coverage.
The planner bases his analysis on the assumption that Walter retires on Jan. 1, 2025, and Nadia on July 1, 2025. Walter starts drawing Canada Pension Plan benefits of $9,800 a year at age 60 and Nadia $11,000 a year at age 65. They both draw Old Age Security benefits at age 65.
Walter’s workplace pension is $106,000 a year, indexed to inflation, while Nadia’s is $50,000 a year, indexed to inflation. The planner assumes they earn an annual rate of return on their investments of 5.45 per cent and the inflation rate averages 2.2 per cent.
“There are some areas in which they can improve the outlook for retirement,” Mr. Sears says. The main one would be paying down the mortgage as soon as possible, he says. “With their plan to retire in one-and-a-half to two years, and the recent interest-rate increase by the Bank of Canada and some economists forecasting another increase again in September of 0.25 percentage points, it would be prudent to pay down the debt now.”
They can then redirect the money they are now paying on the mortgage and their monthly surplus cash flow to build their savings back up.
This would mean that they would use all of their non-registered funds and their tax-free savings account (TFSA) to pay off the mortgage. Alternatively, if they wanted to leave some of the funds in the TFSA, they would direct their monthly surplus to paying down the debt along with using their non-registered savings.
Yet “it’s unlikely that they would find a risk-free return greater than their current mortgage rate, which would be the only reason to leave the funds in the TFSA, rather than paying down the mortgage,” Mr. Sears says. The impact of paying down the debt now with the non-registered savings and TFSA is an additional 4.5 per cent in expense coverage in retirement, the planner says.
Nadia’s pension has some limits on the indexing provision, the planner notes. “The only reason I mention it is I’ve seen a fair number of clients concerned with the CPI [Consumer Price Index] adjustment on their defined benefit plans because inflation has been a popular discussion piece,” Mr. Sears says.
“In a worst-case scenario where Nadia’s pension sees no future CPI adjustment, they would have only 101-per-cent coverage, meaning that they would need to draw from their current investment accounts later in retirement to sustain their spending until age 95,” Mr. Sears says.
If the couple pay off the mortgage immediately, they are left with about $155,000 in investment assets to start. Their assets peak at $502,000 when Walter is 92. At that point, their expense target of $120,000 a year will have grown to $251,946 with inflation, plus $7,500 for gifting.
Their spending is covered by CPP, OAS, minimum registered retirement income fund withdrawals and their pensions. Their after-tax income would be $239,826. They need to withdraw $19,828 from their TFSAs to cover the shortfall in that year. “Each year afterwards, the TFSA withdrawals increase, dropping the investment accounts back to about $180,000 by Nadia’s age 95.”
In this case, the estate value would be about $180,000 in investment assets plus the value of their home, Mr. Sears says.
If they don’t pay off the mortgage immediately, their coverage is only at 96 per cent, meaning they would need to reduce their spending at some point or tap into the equity of their home to sustain that level of spending, the planner says. Their investment assets would run out at age 95 for Walter, and 92 for Nadia, if the mortgage isn’t paid off now, although they would still have the house.
As well, Walter’s plan to take CPP at age 60 should be reconsidered, Mr. Sears says. A portion of Walter’s workplace pension at age 58 is a bridge benefit (estimated at about $13,000 a year). “Once he turns 65 he will see a reduction in pension payments.” The couple don’t need the additional cash flow at Walter’s age 60. Delaying CPP until age 65 would increase the coverage by another 1.7 per cent, increasing the estate value by about $200,000.
In the first full year of retirement, assuming Walter takes CPP benefits at age 65, their income would break down as follows: $108,183 from Walter’s pension, $5,331 from his RRSP, $50,634 from Nadia’s pension and $1,402 from her RRSP, for a total of $165,549 gross. Income taxes would be $31,684, leaving them with $133,865. “This would cover their $125,568 of lifestyle expenses and $7,500 for their gifting goal to the kids,” the planner says.
Client situation
The people: Walter, 57, Nadia, 54, and their three adult children.
The problem: Can they afford to retire soon with $120,000 a year in after-tax spending? Should they use some of their savings to pay down the mortgage?
The plan: Use non-registered and TFSA funds to pay off mortgage now. Redirect the money that had been going to the mortgage to replenishing savings. Walter should defer CPP benefits to age 65.
The payoff: A clear picture of how changes made now will increase or decrease their retirement income and the ultimate size of their estate.
Monthly net income: $11,507.
Assets: Bank account $25,000; house $1,100,000; non-registered mutual funds $165,000; his TFSA $47,000; her TFSA $87,000; his RRSP $102,000; her RRSP $27,000; estimated present value of his DB pension $1,925,000; estimated present value of her DB pension $889,059. Total: $4,366,608.
Monthly outlays: Mortgage $1,989; property tax $533; water, sewer, garbage $150; home insurance $186; electricity, heat $330; maintenance, garden $250; transportation $542; groceries $1,300; clothing $250; gifting, vacation, travel $983; dining, drinks, entertainment $650; personal care $150; sports, hobbies, club membership, subscriptions $542; health care $110; communications $240. Total: $8,205. Surplus $3,302.
Liabilities: Mortgage $330,000 at 5.8-per-cent variable.
Editor’s note: A previous version of this article included an incorrect reference to the clients’ home value and omitted their non-registered mutual funds in the list at the bottom. Neither error affected the planner’s analysis, which was based on the correct numbers. This version has been updated.
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Some details may be changed to protect the privacy of the persons profiled.
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