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Situation: Couple’s pension 50 per cent survivor benefits and RRSPs won’t fill gap when one dies
Solution: Restructure car loan and line of credit to save interest, use B.C. property tax deferral
In British Columbia, a couple we’ll call Helen, 60, and Brent, 64, have both retired. Their present incomes add up to $6,838 per month before tax. They have an adult child who still lives with them, who they charge $400 per month for room and board, making their monthly income $7,238. Despite being retired, they are still saddled with debt, including a $320,000 mortgage, a $30,357 line of credit and a $24,500 car loan. Payments on those debts total $2,250 per month, one-third of their after-tax income. They worry that with those debt payments, they won’t be able to save enough to reach their retirement income goal of $6,000 per month after tax.
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“We should have started our RRSPs earlier and not lived beyond our means,” Helen explains. “We worry we may have to move out of our heavily mortgaged home.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Brent and Helen.
Their first move is to use $10,300 in a bank account earning approximately nothing to reduce debt. The highest interest debt on their ledger is the line of credit that costs them 5.95 per cent interest. That’s $150 per month just in interest. At the rate at which they are currently paying down the loan, $400 per month, it will take seven years to clear the loan. If they use their cash to reduce the debt to $20,057 and then maintain their payments, the loan will be history in four years and save them about $5,400 in interest.
The larger question is whether to sell their house. They fear they cannot afford to keep it. They paid $220,000 for the house many years ago. Its present value is $770,000. They could sell for $731,500 after five per cent fix-up and sale costs, pay off the $320,000 mortgage, then use the balance, $411,500 to buy a condo. With present amortization, the mortgage will run to July 2044.
Living in the house costs the couple $366 monthly for property taxes and $704 mortgage interest not including repayment of principal. Repaying the principal increases owner equity. It is shifting money from one pocket to another. If they sell and buy a condo, they would swap $366 monthly property tax for condo fees — or strata fees in B.C. terminology — depending on the property. They could make use of a B.C. program that defers property taxes until sale of the property for a resettable rate with no compounding. The fluctuating cost with government administrative adjustments has been 1.45 per cent this year. That rate would cut the couple’s taxes by $4,330 per year. They need not move.
There are other ways to manage total interest costs, Moran adds. They could blend and extend their mortgage, adding their line of credit and car loan into a separate first mortgage. Their present mortgage will be paid in full in 24 years if interest rates do not change. The repackaged car and line of credit loans would be financed at rates of about three per cent, which is several per cent less than what they are currently paying, Moran notes.
They should stop $400 monthly RRSP contributions just to fill space they generated while working. They need to cut those debt service costs more than they need future returns of retirement savings.
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Adding up retirement income
At present, the couple’s income consists of two indexed pensions that total $49,344 before tax per year with 50 per cent survivor options for each partner; two bridges to 65 (his $12,276, hers $11,928) which total $24,204; and Brent’s Canada Pension Plan benefit of $8,520 per year started at age 60 due to health concerns. They add RRSP payouts of $4,800 each per year for total income of $91,668 before tax. After splits of eligible income and 14 per cent average tax, they have $6,570 to spend each month. They cover their small deficit by drawing down cash. They need no longer make RRSP contributions. That adjustment brings their budget into close balance with income.
When Brent is 65, he’ll lose his pension bridge but gain $7,290 in OAS, making their total income $86,682 per year. After 14 per cent average tax, they would have $6,212 monthly to spend.
Four years later, when Helen turns 65, her bridge, too, will end, but her CPP of $13,578 and OAS of $7,290 will boost income to $95,622. After 15 per cent average tax, they would have $6,775 per month to spend.
Triggering RRSP payouts requires a strategic judgement of whether the money is needed before age 72, when benefits have to start flowing, tax rates now and after 72, and survivor benefits. The couple has elected not to delay RRSP payouts and years of untaxed growth for immediate payout.
There is some delicacy in this process, for the survivor benefits Brent and Helen chose for their company pensions, 50 per cent each, will leave a significant deficit in their budget when the first partner dies. At that time, half the DB pension, most of one CPP and one entire OAS will disappear. That could be $28,272 per year should Brent die first or $33,078 per year should Helen die first. The survivor can make up the difference by increasing payouts from RRSP/RRIF accounts.
The largest risk in this conservative outlook is a rise in interest rates to double-digit rates that prevailed decades ago. In the next quarter century to the full payment of their mortgage, it could happen, but it won’t be soon. With another decade or two of mortgage payments at today’s low single-digit numbers, refinancing the stump of the present mortgage could be done even with an income slashed by loss of half a pension, one OAS and most of one CPP benefit, Moran says. Sale forced by appreciably higher rates is unlikely.
Retirement stars: Three *** out of five
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