Holding Off on CPP the Key
THEY HAVE ... TOO MUCH INVESTED IN THEIR $850,000 HOUSE. THEY HAVE A $255,000 MORTGAGE, LEAVING EQUITY OF $595,000. THAT’S CLOSE TO THE $650,000 TOTAL VALUE OF THEIR (ASSETS). — DEREK MORAN
In British Columbia, a couple we’ll call Harry, who is 59, and Mary, who is 61, have a pleasant life. Their children are grown and gone and they look forward to retiring in four years, perhaps outside Canada. Mary, a civil servant, will have a pension at age 65 of $1,562 a month, Harry, an administrator, will have a pension of $688 from a former employer starting in late 2017. The couple has $635,000 of RRSP and TFSA savings as well.
At present, they have takehome income from their work of $8,000 a month and rental suite income of $1,200 a month. They put $1,450 into their TFSAs to fill up their individual $ 52,000 space, and $1,830 into their RRSPs and have $ 300 free cash for non-registered savings. Their question — will they have a financially secure retirement if Harry quits his work in project management next year and Mary quits her work in 2020?
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C. to work with Harry and Mary. “They have, arguably, too much invested in their $ 850,000 house,” Moran explains. “They have a $ 255,000 mortgage, leaving equity of $595,000. That’s close to the $ 650,000 total value of their financial assets. “But in this case, other assets can finance their retirement.”
Preparing for retirement requires a close look at their expenses. Take off all saving and their line of credit, which will be paid off by then, and they can get by on $ 5,420 a month. The mortgage at current paydown rates will still have a decade to run before being paid. The question — can Mary’s pension and their savings generate that income after tax beginning when Mary, two years older than Harry, is 65?
Beginning at Mary’s age 65, they will have two job pensions which total $2,500 per month. They can have Mary’s Canada Pension Plan benefit of $670 a month, and her Old Age Security benefit, adjusted for 30 years’ residence in Canada out of the 40 needed for full benefits, of $434 a month. The total, $ 3,604 is about $1,800 a month short of what they would need.
Harry could take CPP two years early at a discount of 7.2 per cent per year for each year prior to 65 at which he begins the benefit. His cost would be a 14.4 per cent discount of the $960 he can expect at 65. That’s $ 822 per month. There is $1,000 to go to fill the gap.
Their investment income based on present RRSP and TFSA assets totalling $ 650,000 with four more years of contributions of $3,000 a month (present contribution rate reduced when TFSAs are topped up), assuming 3 per cent growth to the end of 2017, will be $886,700. If that sum is annuitized so that all principal and income is paid out starting in 2021 for the 30 years to Mary’s age 95, it would generate $45,200 a year or $ 3,770 a month. If Harry were to retire this year and all savings cease, then their present assets would with the same three per cent growth assumption generate $32,200 a year.
Adding up the couple’s company pensions, government pensions and investment income starting in four years when both are retired, they would have $ 2,500 in job pensions, $579 for Harry’s OAS, $ 474 for Mary’s OAS, and two CPP benefits of $1,630 a month. That’s $5,183 a month before tax. Add in the annuitized flow of savings starting in four years, $3,770 a month and the couple’s total income would be $8,953 a month. With splits of eligible pension income and a 16 per cent average income tax rate, they would have $ 7,500 a month to spend, a little more than present spending net of RRSP savings, which totals $7,370.
Mary contemplates retiring in Europe. If they left Canada, their registered income, CPP and OAS would be paid after withholding of 15 per cent. Their $ 850,000 house, if sold for present price less five per cent selling expense, would yield $ 807,500. Take off their $225,000 mortgage and they would have $582,500 for another home or for investment at the same 3 per cent rate in an annuitized payout process. That would generate $29,700 a year before tax.
We can’t estimate tax in a yet- to- be determined retirement country, but if subject to only 10 per cent average tax, Harry and Mary would have $2,200 a month for rent or another mortgage. For now, we’ll assume they do not sell their B.C. house and continue to get $ 1,200 a month rental income.
In their B.C. home, Harry and Mary can postpone their property taxes, $3,840 a year, by use of the B.C. property tax deferral for seniors until sale of their home. They would pay the non- compounding cost of 0.7 per cent per year.
The couple’s portfolio is currently managed by a respectable investment dealer. They could shift from their present blend of growth and value stocks to a few diversified, low-fee, exchangetraded funds. If the switch added one per cent a year to their income, $ 6,350, they could use the savings for travel to Mary’s family abroad.
The final question is timing retirement. Taking CPP before 65, as they might do next year when Harry is 60 and Mary is 62, would mean paying a penalty of 7.2 per cent per year of the age 65 amount for each year before 65 that benefits begin. The costs would thus be 36 per cent of the age 65 benefit for Harry and 21.6 per cent for Mary. CPP is a life annuity and the word “life” is very important. Starting the income flow early is conservative, but it has the consequence of limiting the base for indexation for future increases in the consumer price index.
If Harry and Mary defer the start of OAS, they would get a 7.2 per cent a year boost or 36 per cent in total increase each year to 70. If either partner survives to the mid-90s or beyond, the benefits of postponing the start date for government benefits would be quite large, Moran notes. Still, these government benefits are essentially life annuities. And if benefits are taken early and sums invested well, the gap closes. But making 7.2 per cent a year with no risk of loss is the final factor in the calculation. It’s hard to beat that in the stock market with no risk, almost impossible in investment grade bonds, Moran notes.
(C) 2017 The Financial Post, Used by Permission