Brooke needs to boost investments to save for her son’s education and pay off her mortgage
A woman we’ll call Brooke, 46, lives in Ontario with her son, Carl, who is 13. A school teacher, each month she earns $7,724 from her job before tax, $600 from doing tutoring privately and $1,200 from renting a room in her home. That’s $9,524 per month or $114,288 per year. After 26 per cent average tax, she has $84,575 or $7,047 per month. She adds $202 from the Canada Child Benefit and $300 child support, neither taxable, for after tax income of $7,549 per month. She wants to retire in nine years at age 55. ”Will retirement work five years before I can take CPP and 10 before OAS?” Brooke would need to plan for her assets and pensions to support her for about 40 years.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Brooke.
“She is doing well in financial terms,” Moran says, but will need to address her priorities in the right order.
A question of sequence
Brooke’s priorities speak for themselves: Post-secondary education starting in seven years, paying off the outstanding mortgage balance in 15 years and retiring in nine years at age 55 with a pension of $53,650. Timing is everything, for in the next decade she must accumulate sufficient investment assets to provide income to fill some of the approximately $46,658 gap between her pension and present income, while at the same time saving for Carl and paying off her mortgage.
It is usually a good idea to retire with no debts. Brooke’s present $286,000 mortgage balance, costs her $1,740 per month. She could add $1,000 per month so that it would be paid in full when she retires in a decade, but, she says, she does not have enough cash flow after living costs and paying down her $50,000 home equity line of credit to raise payments that much.
In reality, if she totes up all her income sources, she does have the means to complete an accelerated payoff. Her $50,000 Home Equity Line of Credit could also be paid down by raising $3,000 annual payments to $5,500. A little more tutoring would cover it. Even if she carries the HELOC into retirement, she will have income to service the debt, Moran estimates. Using present spending and income from 55 to 65, she can do it.
Building retirement income
Brooke’s RESP has a $21,750 balance. She adds $50 per month and $200 now and then, but she appears not to be making full use of the annual maximum $500 maximum Canada Education Savings Grant. If she raises her contributions to $2,500 per year, the CESG will provide the top-up to $3,000. Looked at as an investment, the CESG offers an instant 20 per cent profit
The present RESP balance plus $3,000 annual contributions, growing at three per cent per year after inflation for the four years to age 17 when the CESG stops would grow to $33,300. That sum would provide three or four years of tuition and books for most post-secondary institutions in Ontario. Summer jobs could make up the difference.
If Brooke is to retire at age 55, she will need income in addition to the base pension of $53,650, which would only leave $44,039 after 18 per cent average tax. That works out to $3,670 per month, would not cover even a slimmed-down monthly budget of $4,344, including present mortgage payments and $275 per month for life insurance.
There are economies she can make. She could cancel $274 per month for life insurance on top of the one-year’s annual income her job provides. At her death, Carl will inherit her estate with perhaps $600,000 to $700,000 in value. She does not need to have insurance to benefit Carl, Moran explains.
Brooke has $1,000 in her RRSP and nothing in a TFSA. In her bracket, contributions to an RRSP can produce a tax refund of about 43 per cent — her marginal tax rate. She is limited by the Pension Adjustment to a limit of 18 per cent of gross income less pension contributions through her work. We can estimate that she has $9,000 RRSP room each year. She can add $3,000 per year without strain. If she does add $3,000 per year to her present $1,000 RRSP balance and if the total grows at 3 per cent per year after inflation for 10 years to her age 56, it will become $36,800. This sum, annuitized to pay out all income and principal for the following 34 years to her age 90 would generate $1,700 per year.
Retirement income
Her income from retirement to 65 when she can access full CPP and OAS benefits would be her pension $4,470 per month including a $581 monthly bridge to 65, and $1,700 from her RRSP. That’s $6,170. Add tutoring at $600 per month and she would have $6,770. If she continues to rent a room for $1,200 per month, her retirement income would be $7,970 per month before tax. She would no longer have income from the Canada Child Benefit nor child support, but after 23 per cent average tax, she would have $6,137 per month to spend. That would be a margin of about $2,000 over cost with no debt service nor life insurance or child care costs.
From age 65 onward, she would have her base pension, $46,668 per year, estimated Canada Pension Plan benefits of $11,994, and Old Age Security of $7,362 per year. If she has stopped renting a room and tutoring, that adds up to $66,024 before tax. After 15 per cent average tax, she would have $4,675 per month to spend, a little less than the $5,000 she spends now. With no child care, debt service, or life insurance premiums, she would have substantial discretionary income.
She can raise educational savings for Carl. Child support payments from her ex-husband and the Canada Child Benefit would have ended by the time Carl is 18, but she can fill the gap by tutoring, as she has often done.
