Financial Post Article: Ottawa couple aiming for simple retirement worry inflation will derail their plans

The Financial Post asked me to review the finances of an Ottawa couple who are worried that inflation will take away money from their pension plans.

See how looking at their additional lifestyle spending will make a difference for their retirement.

• How much do they really need per year to retire on their desired lifestyle?
• How do they start taking money from their RRSPs? How much is smartest?
• When should they convert their RRSPs to RRIFs?
• How does the way they invest affect their retirement income?
• When should they start CPP & OAS?
• Why should they delay CPP & OAS for John, but not for Cathy?
• Can they afford to leave an inheritance for their nieces and nephews?

CLICK THE LINK BELOW TO READ THE ARTICLE BY MARY TERESA BITTI:

Ottawa couple aiming for simple retirement worry inflation will derail their plans

Financial Plan Summary & Client questions:

John is 62 years old and plans to retire at the end of 2023. He is married to Cathy, who is 55 years old and plans to retire in the next five to eight years. 

John is a programmer analyst and has worked with the federal government for 32.5 years. He currently earns about $90K gross (about $60K net). His government defined benefit pension plan is indexed to inflation and will pay $62K gross per year if he retires as planned at the end of this year. Part of the pension is a bridged benefit to approximate CPP until age 65. 

Cathy works in the private sector and earns about $60K a year gross. Her employer converted their once defined pension plan to a defined contribution plan and she put it into a Locked In plan. She doesn’t know at this point how much that will be worth/pay out when she retires. 

Both John and Cathy each have about $60K in RRSPs invested in moderate risk mutual funds. They have $3,000 in cash.

The couple own a single-family home in Ottawa worth about $500K. They have no mortgage and no other debts. Their current monthly expenses run about $3,000.

John says they live modestly and have no big plans for retirement other than to pursue interests (i.e., he wants to learn to play guitar), so long as they can afford to.

They aren’t big travellers but would like the comfort of knowing they could afford a trip if they wanted. If they were to splurge, they’d like to purchase a swim spa which would also require some home renovations so it could be used year-round.

He thinks it would require about $80K to $100K and they would take out a mortgage on their house to do it. That said, this is not something they’re working towards as their biggest priority is to ensure they’re comfortable in retirement. John has no desire to work after he retires.

Is this (retirement this year) going to work?

Ideally, I’d like an overview of our financial picture:

Here’s what I have now, what does that look like in the future if I retire this year?

Lifestyle expenses about $3,000/month + $1,000 every second month = $3,500/month = $42,000/year = $46,000/year before tax. Pension alone is more than this.

This is not their total lifestyle – just their regular bills.

Does this include all their lifestyle, such as entertainment, vacations, gifts, medical, buying cars, or other fun activities?

Based on things they said, I added $2,500/year for medical (benefits probably stop when he retires), $5,000/year for vacations (minimal, probably should be more) & a $68,000 car every 10 years (assuming they want to keep a similar car & drive it a long time).

Total is $56,000/year ($4,700/month) to spend = $64,000/year before tax for a desired retirement lifestyle.

Once both retired, about $6,700/month after tax = $81,000/year total. This is $97,000/year before tax.

Split his pension with $18,300 to make their taxable incomes the same. Save $1,500/year in tax.

Brings retirement income to $6,900/month to spend = $82,500/year.

Bottom line: They can retire comfortably on their current lifestyle + health costs + some travel + $68,000 car every 10 years + $2,200/month more after tax.

Their desired lifestyle is quite a bit less. They can both retire today above their desired lifestyle.

Recommend: Think about what to do with the extra $2,200/month. Is the desired lifestyle I worked out enough for them to live the way they want? If they do nothing, they will end up slowly spending more and eventually the $2,200/month will become part of their lifestyle spending.

They would be smart to save & invest some, so that they have investments they can draw on for emergencies or other things they want to do in their lives in the future. Perhaps bucket list things or home renovations. They could also invest it to have an inheritance for the nieces & nephews.

How much money will I have coming in and what is the best way to draw down funds?

Once both retired, about $6,900/month = $82,000/year after tax total.

John’s pension (excluding CPP bridge benefit & after spousal deduction 10%) $41,000/year

John’s CPP (at retirement) $15,000

Cathy’s CPP (at retirement)                                                                                   $16,300

John’s OAS (at 65)                                                                                                  $9,000

Cathy’s OAS (at 65 – 7 years later than John)                                                         $11,100

John’s minimum RRIF ($63,000 * 3.7%)                                                                   $2,300

Cath’s minimum RRIF ($89,000 * 3.7%)                                                                    $3,300

Total Income before tax                                                                                            $98,000

Income tax                                                                                                                 $15,500

Total Income after tax                                                                                                $82,500

Split his pension with $18,300 to make their taxable incomes the same. Save $1,500/year in tax.

Includes minimum RRIF & start CPP when both retired.

He’d also like to understand the rules around RRSP

Convert to RRIF & LIF when they retire (ideally January 1 the next year).

Minimum withdrawal at age 63 is 3.7%. That is about $2,300/year for John & $3,300/year for Cathy.

Cathy retires 7 years later so her RRSP grows for 7 more years.

Recommendation: Both should start when Cathy retires at age 70 for John & 63 for Cathy. Convert RRSPs to RIFF & LIF and take minimum withdrawal.

What is OAS? How does it work? Would they clawback money because I earn too much? When should I claim it?

Old Age Security. Government pension that starts at age 65. No pension fund – paid from current year tax revenues.

About $9,000/year for John & $11,100/year for Cathy. It’s clawed back if their taxable income is above $87,000/year each.

With pension splitting, their taxable incomes should only be about $48,000/year each, so no clawback.

The same question applies to CPP. Should he wait to 65 or later to claim it or should he start claiming it when he retires at the end of the year and have that extra money? 

They can start CPP between age 60 & 70. It is an implied return of about 5%/year to delay. This is based on the rate of return it would take to provide a similar income (if you invest all the early year’s CPP & then make your income the same as a later start CPP).

The main factors for deciding when to start are investment returns & tax. (Most writers miss these 2 main factors.)

Since they invest in balanced mutual funds, their rate of return should be similar to CPP, about 5%/year.

Their taxable incomes after retiring should be about $48,000/years, so all at the lowest 20% tax bracket, but at $49,000 it increases to 24% and $53,000 to 30%. Delaying CPP means risking being in a higher marginal tax bracket at age 70, so it’s best to start when they both retire.

John is in a higher tax bracket now while working and also after retiring with his pension. Once Cathy retires, they can split $18,000 of John’s pension to Cathy on their tax returns so they can both be at the lowest tax bracket.

They are in similar situations based on investment rate of return vs. CPP, so the tax savings is the main factor. They will probably pay less tax if they start John’s CPP & OAS at age 70 when Cathy retires, Cathy’s CPP at 63 when she retires and Cathy’s OAS at the earliest age of 65.

Can they afford a swim spa?

Yes. They can only pay for it with a mortgage on their home. They should pay it off slowly to have a minimal payment. A $100,000 mortgage at 4.5% (long-term historical average) over 25 years is about $550/month.

They have $2,200/month extra, so they can afford to buy the swim spa, if they want.

Inheritance for nieces & nephews?

Their RRSPs will be minimal or gone when they pass away. All they have is their home. It is paid off, so it could be a good inheritance once they are gone. That is likely to be 40 years from now.

How much do they want to leave for them? Is the house enough or soon enough? They could invest part of their extra $2,200/month to build up an inheritance to give them when the time is right.

Ed