Situation: Couple at 40 with two young children wants a sabbatical soon, then retirement at 55
Solution: High savings rate plus a solid track record in stocks fund education savings and retirement
A couple we’ll call Vince and Linda, both 40, make their home in Ontario with their two children ages 3 and 6. A financial systems manager and a civil servant, respectively, they bring home $12,730 per month. They have a home with a $900,000 price tag and about $1.56 million in financial assets. Their debts are a mortgage and a car loan that add up to $158,000. Their net worth, an impressive $2.3 million, is exceptional for their stage in life. Vince, an accomplished investor, has provided the family with substantial financial security. Yet they are prepared to risk it with a plan to retire in as little as a decade and a half.
“Could we retire in our early or mid-50s with an after-tax income of $80,000 a year to do non-profit work?” Vince asks.
Quitting their jobs well before 60 year would stress their retirement. Their issue, therefore, is whether another 15 years of work backed up by diligent investing can support what might be four decades of retirement.
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Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Vince and Linda. “The family has an impressive ability to save, invest and pay off debt, but quitting so early will take a lot of careful planning. They can’t afford to make big mistakes with such a long-range plan.”
Allocations now and then
The couple’s spending is modest and will be even more modest in future. Present monthly allocations include $1,559 for RRSPs, $417 for RESPs, $917 for TFSAs and $1,450 for child care and activities. If they begin retirement in, say, 10 years at age 55, the kids would still be dependent. But 15 years from now, when the kids are 18 and 21, the family’s finances will be quite different.
If their retirement starts at their age 55, they could spend $6,246 per month and be pretty well within their after-tax budget. Their $867 per month interest-free car loan would be paid and their mortgage, $1,274 a month with a 15 year amortization, would be history, as would child care at $1,450 per month. They would end RRSP and RESP savings, a total of $1,976 per month. Cash savings at $1,200 per month would end.
Vince and Linda are well diversified. Their house has a modest mortgage of $132,000. They could easily pay down the mortgage, but at its present rate, 2.02 per cent and affordable payments of $1,274 per month, it’s no problem to carry it and use nearly $60,000 cash they hold for investments that would return several per cent more.
Educating the kids
The family RESPs total $46,153. If the parents maximize contributions to achieve the Canada Education Savings Grant limit of $7,200 per child, which would happen when each is about 14.4 years old, they would have 8.4 years and 11.4 years to invest $2,500 per beneficiary plus $500 from the CESG, total $3,000 per year per child, and with growth at 3 per cent over inflation, the kids would have $59,000 and $74,000, respectively for post-secondary education. The parents could average the sums to $66,500 to provide four years of tuition and books at any post-secondary institution in Ontario.
To achieve their retirement goal, $80,000 per year after tax, should not be hard. Linda can expect an unreduced pension at age 55. It would be about 60 per cent of her present $91,000 salary or about $54,600 per year. That’s their retirement foundation.
The couple’s RRSPs currently total $481,123. If they add $18,708 per year for the next 15 years and achieve a rate of growth of 6 per cent less 3 per cent for inflation, the RRSPs would grow to $1,097,500 and the annuitized payouts for 35 years would rise to $51,100 per year in 2018 dollars using the same 3 per cent annual real return for the calculation.
Their TFSAs, $148,834 with the addition of $11,000 per year for the next 15 years to their age 55 with 3 per cent annual growth after inflation would become $442,680. Annuitized for the next 35 years to age 90, that sum would generate $20,600 per year with the same return and inflation assumptions.
Their taxable account with a present value of $819,528 with no further contributions would grow to $1,277,000 and support payments of $59,430 for the next 35 years, again with the same assumptions.
CPP would pay each an estimated $11,600 per year at 65. Each could receive Old Age Security at $7,040 per year using 2018 rates less the clawback which begins when income rises over about $75,000 and takes 15 per cent of each dollar thereafter. We’ll assume that the clawback takes all of their income and thus leave OAS at zero for each partner.
Adding up components of future income assuming that Vince and Linda work to age 55 and then retire, they would have about $186,000 before tax to age 65 and then, with the addition of CPP benefits, $208,930 before tax. Removing TFSA income, $20,600 per year, the sums decrease to $165,130 and $188,330. After splits of eligible pension income and other income from shared investments, they would pay tax at an average 30 per cent rate and have $11,370 to spend before 65 and $12,700 per month after 65.
The figures for retirement income are large in this case, but they make sense. Vince has transferred his skills in financial management to his family investments and, backing his results, Linda has a nearly bulletproof pension from a local government. Even if Vince’s investments were to lose half their value at retirement, they could sustain their expenses.
“There is no doubt that Vince and Linda can retire at 55 and meet their retirement income targets and a good deal more,” Moran concludes. “With their demonstrated skill in investing, they could add perhaps one per cent to their rate of growth in all portfolios other than the RESP, which should be conservatively invested.”
“Financial management skills and one solid job pension have given this couple the ability to retire as early as 55 and then to exceed their retirement income expectations,” Moran says. “They can shift their work to good causes and even provide a legacy for their children.”
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Retirement stars: Five retirement stars ***** out of five