On initial review of the situation Bill and Amy seem in good financial shape. They earn good incomes and have a net after-tax income, assuming basic personal exemptions for each, of $18,068 per month. Also, even with additional expenses, their monthly commitments are low at $6,450, leaving a monthly surplus of $11,618.
The real strength of their retirement income lies in their defined benefit pension plans. It is likely that given the years of service by their retirement ages, they will each receive 70% of their Final Average Earnings (FAE). In some pension plans, this is three years; in others it is five years, which is what I have used in my analysis.
Projecting salaries to grow at 3%, Bill has an FAE of $215,217, and will, thus, receive a pension of $150,582. This is 66% of his last year’s earnings.
For Amy, her FAE equals $177,502, producing a gross retirement income of $124,241, also 66% of her last year’s income.
Many plans have an age 85 rule. It’s a formula—number of years of service, plus age—that helps people decide the timing of their retirement. If the total number is more than 85, you are allowed to retire without having to take a pension cut. This will allow Amy to retire at the same time as Bill with an unreduced pension. Provided Amy joined early in her career (assume age 30) her age plus service would surpass 85 by the time she is 63, when Bill is 65.
Another good piece of news is that the pensions are payable for life, however long that may be. The survivor would receive 50% to 100% of the pension at death depending upon the pension option chosen. This eliminates any risk of longevity or outliving financial resources.
In addition, each would receive CPP pensions, assuming the Registered Pension Plan (RPP) is a non-integrated plan. (2014 amount is $12,459.96 each and this increases every year because of CPI.)
In short, there is no real pressure to save additional funds to enjoy a comfortable retirement.
Given this base-income security, they should plan on deferring receipt of their RRSPs until age 71. Further, the $100,000 in combined RRSPs, assuming a 5% return, will be worth $207,893 when Bill’s is 71 and Amy is 69.
The two negatives of being involved with the defined pension means that, because of the Pension Adjustment rule, both Bill and Amy will have only a nominal amount they can contribute to an RRSP. In their case this isn’t a big issue, however. They don’t need to save in RRSPs.
The second negative is that both of them will have no Old Age Security as it will be fully clawed back. (For 2014, the tax recovery applies to persons whose net income exceeds $71,592. For each $1 of income above this limit, the amount of basic Old Age Security pension reduces by $0.15.)
The three key issues that need to be addressed are:
- The funding of son James’s education. Currently age 15 and only $30,000 accumulated. Projected cost, assuming he lives away, to cover tuition and room and board is $75,105 for four years of schooling.
- The 15 years still left on the mortgage.
- The future cost of long-term care. When Bill’s dad enters a facility the co-payment amount per month can be as low as about $1,600 for three-bedroom ward care to about $2,200 for a private room.
Let’s address each of them separately.
If Bill and Amy annually save $5,000, the first $2,500 qualifying for Canada Education Saving Grants (CESG), they will nearly achieve the cost of four years of education assuming a return of 4%. They will be short about $3,816 in the final year.
It is likely they haven’t fully contributed in the past so they can carry forward unused room and receive up to $1,000 in CESG. With a $5,000 deposit, they can get maximum CESG of $1,000 per year.
Mortgage on home
It would be prudent to escalate monthly payments to shorten the amortization period of the mortgage if they were considering downsizing their home at some point in the future. There is a lot of tax-free equity they could unlock if they indeed did downsize.
The annual cost of this could be from $20,000 to $26,500 depending on the type of accommodation.
If they move their non-registered savings to a 60% equity-40% income “T-Class” mutual fund paying an annual distribution of 5% of the prior year’s market value, the income will be 100% tax-free for the first 14 years.
The income secured will range from a low of $7,500 in year one to a high of $12,937 in year nine. Given their tax bracket, they would have to withdraw significantly more to achieve a similar after-tax cash flow.
Alternatively, they could sell Bill’s father’s home as both parents now live with Bill; they could employ the same approach as discussed above.
The other piece of the puzzle is that they haven’t maximized their TFSA accounts. They can catch up, and when the car loan is paid off, they should redirect the payment into the TFSA and make withdrawals as needed to offset the long-term care costs beyond the T-Class payouts.
As for their summer and winter vacations, these could easily be financed from cash flow and deposited into a monthly high-interest savings vehicle. The recommended amount to save is $850 a month.
Finally, they both should consider critical illness coverage. The expenses they faced with Bill’s parents would have been covered had Bill’s dad or mom had critical illness insurance. Knowing the costs firsthand, it would be wise to take some money now to cover them until age 65, when their pensions commence, so the expenses wouldn’t fall to their two sons.
In summary, with a little fine-tuning, they should be able to achieve all of their objectives and have peace of mind from knowing that they will.