A woman we’ll call Lena, 46, lives in B.C. with her 10-year-old daughter, Kim. Lena takes home $5,120 per month from her job in data-based package management systems for a shipping company and adds $1,200 in child support, $283 for the Canada Child Benefit and $190 in rental income for total after-tax income of about $6,793 per month.
Lena’s chief problem is debt. She has a mortgage balance of $304,000 for a rental condo with a three per cent floating interest rate; an unsecured credit line with a $26,000 balance at an interest rate of 8.44 per cent; and a car lease, essentially a loan, that costs her $400 per month but that expires in just a few months.
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Lena would like to retire at 65 with $3,000 in monthly after-tax income after paying off her debts and building up her RRSP, TFSA and other assets. A relatively new Canadian, she will have only 24 of the 40 years required to have full Old Age Security benefits at age 65. As well, her limited participation in the Canada Pension Plan will cap her benefits below the maximum.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. of Kelowna, B.C., to work with Lena.
Lena’s largest investment is her rental condo, which cost her $325,000 and has a present estimated value of $345,000. After annual costs $13,920 for interest, property taxes, insurance and fees, it leaves her with an annual return of just $2,280. The net income is less than one per cent per year on her original cost. It is a poor investment from a cash-flow perspective.
If Lena were to sell the rental and get $327,750 after five per cent selling costs, she could pay off her $304,000 mortgage and then have $23,750 to reduce her costly line of credit to a small and manageable sum of $2,250. With present payments of $350 per month, the line of credit would be history in six months.
With the mortgage and line of credit paid, she would liberate $1,100 per month that can be used more productively.
Lena has $6,400 in Kim’s RESP and adds $100 per month. That’s $1,200 per year, about half the $2,500 contribution needed to attract maximum Canada Education Savings Grant of the lesser of $500 or 20 per cent of annual contributions. If she can bump up her contributions to $208 per month, perhaps using some of the $400 monthly car lease payments which will end soon, then the fund would grow to $31,550 by the time Kim is ready for post-secondary education at age 18. Kim would have $7,887 per year for four years for tuition and books if, as planned, she lives at home.
Lena has a monthly salary of $6,540. That’s $78,480 per year. She also gets an annual bonus of $4,200 so her pre-tax annual pay is $82,680. Her RRSP contribution room is 18 per cent of that sum or $14,880 per year.
If Lena uses that limit, she could add $1,240 per month to her RRSP. She already contributes $100 per month, so the net monthly increase would be $1,140.
Lena’s RRSP has a present balance of $2,470 after a 35 per cent markdown due to the ongoing contraction. If she adds a total of $1,240 per month, then with three per cent annual growth after inflation, the account would have a balance of $389,300 in 19 years at her age 65. That sum could then support payments of $19,270 per year for the 30 years to her age 90.
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The $14,880 annual RRSP contributions would produce tax refunds of about $4,000 per year. Those refunds could go to Lena’s Tax-Free Savings Account, boosting contributions of $1,200 per year now to $5,200 per year. It has a paltry $400 present balance. Assuming that Lena maintains the contributions with year-end top-ups from tax reductions from RRSP contributions for 19 years to her age 65, the TFSAs balance still growing at three per cent after inflation would rise to $135,227 and then support payouts of $6,700 in 2020 dollars for 30 years.
Lena’s retirement income will be composed of her private savings in RRSPS, TFSAs, CPP and OAS.
Lena entered the Canadian workforce in 2015 at age 41. If she works to 65 and contributes to the Canada Pension Plan for 24 years and gets credits for child-rearing years, then she would have 68 per cent of the present $13,855 maximum benefit. She would receive $9,421 per year in 2020 dollars.
Lena’s OAS calculation will be based on arrival in Canada at age 41. She needs 40 years residence in Canada by age 65 for full OAS benefits and will thus only receive 24/40 times the present maximum benefit of $7,362 per year, or $4,417 per year.
Assuming that Lena works to 65 and then retires, she will have income of $19,270 from RRSPs, $6,700 from her TFSA, $9,421 from CPP and $4,417 from OAS. That adds up to $39,800 per year.
After 10 per cent average tax but no tax on TFSA distributions, she would have about $36,500. That’s $3,040 per month, a little over her $3,000 after-tax monthly income target. She would still be a renter and rent increases could imperil her standard of living. However, she would be debt free.
A single person, Lena would have no spouse with whom to split eligible income. “Even with a late start and a recent market meltdown, this long run plan should work,” Moran concludes.
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3 Retirement Stars *** out of 5