There’s one thing you can tell clients who foresee retiring before paying off the mortgages on their principal residences: They’re not alone.
“It used to be people didn’t think they could retire until they paid off the mortgage,” says Jason Pereira, senior financial consultant at Woodgate Financial & IPC Securities Corp. in Toronto. “Now people are carrying debt into retirement. I think they just got used to the simple fact that they’d been carrying debt their entire lives and it doesn’t seem to bother them.”
Comfort with debt notwithstanding, there are generally two client types in play.
The first are people for whom, as Pereira puts it, “Life happened. Things didn’t go according to plan. They wanted to get it paid down but they had emergencies. They had needs.”
And then there are those who never made paying down debt a priority.
“It takes more than [the lump sum] you owe to pay off a mortgage because of the interest payments,” he says. “And that has a massive effect on the retirement projections, because the need to sustain a cash flow to meet that debt does take away from retirement capital.”
If a mortgage can be prepaid tax efficiently, either through an inheritance or windfall (or by cleaning out a TFSA in some cases), that’s always the first choice. And, depending on the couple’s tax bracket, it can make sense to withdraw from an RRSP.
“Show me a guaranteed rate of return paying close to 4% with no risk. That’s the return on paying off your mortgage – and to a high-income earner, saving 2.5% on mortgage interest payments is the same as earning 5% pre-tax,” Pereira says. “And it’s not just a return, it’s a dual impact because it reduces your cash flow need faster and reduces the amount of money you need to live off each year. That just makes your retirement more sustainable.”
Timing is everything
The problem with debt is it puts a gun to a client’s head. He or she has to generate enough income to support that debt, because default isn’t a realistic option.
“We’re seeing some people go into retirement with debt, but it’s paid off within the first couple of years, so it’s not having a long-lasting effect,” says Pereira. “But there are others where you’re looking at schedules of them paying off the mortgage 10 to 15 years after retirement.”
Persistently low interest rates make the scenario less problematic, he adds. In some cases, a couple could pay off the mortgage faster but doing so would require taking a larger income stream from a RRIF – pushing them into a higher tax bracket. In those circumstances, it generally makes sense to pay the mortgage off slowly, while keeping an eye on how rates change.
And, increasingly, a client will opt to work the extra 18 months needed to pay off a mortgage.
“As part of the financial planning process, we stress-test our plans by looking at what happens in low- to zero-return scenarios, and in many cases people carrying some debt into retirement have very high probabilities of success,” says Pereira. “It doesn’t mean they’re failing; it just means the free cash flow – after factoring in proper tax planning with an RRSP and other needs – is not sufficient to pay it off prior to a certain date.”
Sell the house?
Pereira sometimes cautions couples against emphasizing debt repayment to the point where they do something foolish from a tax standpoint.
For example, a couple going into retirement with $180,000 on a mortgage and $2 million between them in RRSPs is in a good position to service the remainder of that debt.
There have, though, been cases where he’s advised couples to sell their homes because the mortgage was too great a strain on resources.
“We book a separate conversation and discuss the scenario very calmly,” he says. “These people aren’t delusional. They typically know they’re not in great shape. They know they’re going to have to make some sort of hard choices in the future.”
If downsizing is necessary, Pereira typically counsels couples to make the move no later than in their early 70s, because acclimating to a new home becomes more difficult as people age.
Philip Porado is a veteran Toronto-based journalist who specializes in financial and business topics. Prior to immigrating to Canada in 2004, he covered brokerage compliance, real estate, housing policy, architecture and technology for several U.S. publications.