Situation: Early 40s couple wants to take a year-long sabbatical if they can afford it, retire in 50s
Solution: No kids, ample defined benefit pensions and adequate savings rate should make it work
A couple we’ll call Nancy, who is 41, and Larry, who is 43, live and work in Ontario. They have a bouquet of university degrees, no kids, a couple of pedigreed pooches, a mid-priced condo, and a lot of anxiety about their financial future. Though both have secure jobs — his in a crown corporation, hers in a government bureaucracy, they feel they are caught in a trap of high living costs and a very uncertain future. For now, they bring home $9,100 per month.
“We want to pay off our mortgage fast and we are doing that, but then we want to have a sabbatical so that we can travel and take care of our aging parents, and we want to retire in 14 years at ages 57 and 55 with an after-tax income of $6,000 per month,” Nancy explains. “Can we do all that?”
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Larry was burned by investing in a famous failure, Nortel Networks, which devastated all of his small savings at the time. He anguishes over spending anything, though he has a thing for fine canoes. For now, Larry and Nancy are cautious in their spending, meticulous in their accounting, and very worried about the next few decades until they retire.
“They have boosted their mortgage payments to $2,930 a month,” explains Caroline Nalbantoglu, a financial planner who heads CNal Financial Planning Inc. in Montreal. “Those hefty mortgage payments reduce their cash flow for other things and do not give them any wiggle room in spending or investing. But once their mortgage, currently just $18,000 outstanding, is paid off in 2018, they will be in a good position to afford the sabbatical they want.” To finance it, their employers will put them on 75 per cent of full salaries for four years, cutting savings capacity. Then, in 2022, they will take their year off.
After the sabbatical, they will be on salary again with no mortgage payments. Money that has gone to pay the mortgage will be liberated for savings or anything else, for that matter.
The problem is getting from here to there. They contribute $400 per month to their RRSPs to pay off their Home Buyer’s Plan loans (they borrowed from the plans for their condo down payment). They have four more years to go to pay off the loan. They are committed to that goal, but in the four years before the sabbatical, they will eliminate other savings while their employers cut salaries to finance the fifth year off.
Whether to continue to contribute to their RRSPs after the HBP loans are paid and they return from sabbatical is questionable. Their present marginal tax rates are 30 per cent for Larry and 37 per cent for Nancy. In retirement, they might each have a 30 per cent marginal tax rate. They can continue to make RRSP contributions at $4,800 per year for nine years after their return from sabbatical in 2023, the planner suggests, even though the tax savings would be modest. On the assumption that they do this, then they would have $207,300 when their retirements begin when Larry is 55.
Each has TFSA room in 2018, but Larry has only about $15,980 in his TFSA and Nancy $16,600 in hers. They can use present cash on hand, $8,500 to fill some of their TFSA space, then add $11,000 per year to the accounts every year for 9 years after their return from sabbatical. Their TFSAs would have combined balance of $268,100 in 12 years when their retirements begin.
At retirement in 12 years, they will have defined benefit pensions of $30,900 for Nancy and $54,080 for Larry. Both are registered pensions and can be split. Their total income before tax would be $84,980. After 15 per cent average tax, they would have $6,020 to spend each month. Their expenses with no RRSP nor TFSA contributions nor other savings and no mortgage payments would be just $4,173 per month.
At age 60, Larry can apply for Canada Pension Plan benefits. He could take CPP with a 36 per cent cut from the age 65 benefit, but given that he would not have been working after age 57, and Nancy not since age 55, they can start CPP when each is 60 at an assumed rate of $8,557 each. Thus at age 60, their combined income would be $102,100 before tax or, after 16 per cent average tax, $7,145 per month. At 65, their pensions will be reduced to $40,300 for Larry and $19,776 for Nancy. At 65, each will receive Old Age Security at $7,040 each using 2018 rates. Their total pension income will then be $91,270. After 14 per cent average tax, they would have $6,540 to spend each month.
If the couple has not tapped RRSP nor TFSA savings before Larry’s age 71 when they must start RRSP payouts the next year, their combined savings would be $786,000. If this sum were annuitized so that all income and capital is distributed by Nancy’s age 95, it would generate $45,150 per year. This would push their permanent income to $136,420 per year. After splits of eligible pension income and no inclusion of TFSA payouts, they would have $9,550 to spend each month. They would not be exposed to the Old Age Security clawback which currently starts when annual pre-tax income reaches about $75,000.
There are several unknowns in this income projection, Nalbantoglu explains. The sabbatical year will force each to buy back a year of pension non-contribution. As well, though we have assumed a real 3 per cent annual pre-tax return on all financial assets, the actual rate could vary substantially in the four decades between retirement when Nancy is 55 and the termination of her annuitized cash flow from financial assets forty years later. Even if their financial assets are depleted when Nancy is 95, pension plan income, CPP and OAS benefits would continue to flow.
Their plan to take a sabbatical year financed by four years of company salary banking, dedicated savings and frugal spending should make their plan work. “Given the diverse sources of retirement income, the plan should carry them through their sabbatical to early retirement and old age,” Ms. Nalbantoglu concludes.
Retirement stars: Four retirement stars ****out of five