Can I afford to live in my own home when I stop working?
In British Columbia, a woman we?ll call Edna, 58, is trying to rebuild her financial life after a divorce that, though amicable, stripped her investments nearly bare. Her two children, both in their early twenties, live with her while attending university.
Edna?s issue is how she can translate her $50,400 current annual take-home income into retirement in nine years at age 67. After large costs incurred in divorce, she has just $131,000 in financial assets. Her home, with an estimated value of $500,000, is mortgage-free. Her present cost of living is low. Her job, selling industrial products to numerous accounts throughout British Columbia, provides a car, covers car expenses, cellphone bills and many meals on the road. In retirement, however, she will have to start paying those bills.
?Can I afford to live in my own home when I stop working? Will I have to sell it to get capital for retirement?? Edna asks. ?I am at a loss as to what I should do.?
Family Finance asked Adrian Mastracci, a portfolio manager and financial planner who heads KCM Wealth Management Inc. in Vancouver, to assist Edna.
?There is not a lot of income to work with in this case, but we can boost her retirement savings and help her move toward her goals,? he says.
Cash management
Edna already has a plan for increasing cash flow. She intends to refinish her basement into two small suites for international students, who will pay $800 rent each for 10 months of the year, adding $16,000 to total income. She plans to begin renting the suites next fall.
Out of her $4,200 monthly take-home income, Edna pays $750 a month to help each of her children. She is able to save $700, or 17% of take-home income. That is a remarkable rate of saving for a middle-income single person. It is, of course, due to her ability to support some of her household and personal expenses with her job?s expense account, car and other perks.
Recently, she has held this surplus in cash. If she maintains this rate of saving for nine years and gets a 3.0% return after inflation, she would have $251,000, including $125,000 of current financial assets. That capital would generate $7,530 a year at 3.0% before tax. She should receive full Canada Pension Plan benefits of $11,840 a year at 65 and $6,540 in annual Old Age Security benefits at age 65. She would still be renting her basement suites at $16,000 a year, pushing total income before tax up to almost $42,000. After an average 10% tax rate with B.C. and federal tax credits and accounting for her rentals, her monthly income would be $3,143. All figures are in 2012 dollars.
Retirement plans
If Edna adds $18,000 a year, which she spends helping her children with university costs, for seven years after her younger child has finished the first degree in two years, these savings would add $126,000 to her total savings on the eve of retirement. If this capital earns 3% before tax, or $3,780, her total income in retirement would be $45,780 before tax or about $3,434 a month after 10% average tax.
She would be able to cover present monthly expenses without university costs but not future expenses when, without a job, she would have to pay many costs now covered by her employer. However, her two-year income boost from government pensions when she works from 65 to 67 could create a contingency fund of about $16,000 after tax to defer some of these costs, Mr. Mastracci notes.
Her supplemental medical and dental insurance premiums, now covered by her company, will become her responsibility at retirement. In retirement, she may want to replace the term insurance now provided by her company. Her car, currently provided by her employer, would have to be replaced by one that she owns. On top of that cost, she would have to spend perhaps $200 a month for gas, repairs and insurance.
Travel expenses, which she now covers with free nights at resorts owned by hotel chains whose rooms she uses on business trips, would be hers to pay. If the sum of these costs adds $1,000 to $1,500 a month to her cost of living, her retirement budget could be in the red. The car and travel might have to be sacrificed. She will have the option of downsizing her house in a pinch.
Edna is not even making full use of potential tax savings. She has not made contributions to her registered retirement savings plan or to her tax-free savings account for several years, though both have balances from prior contributions. Adding to them now is among the things Edna can do to improve her rate of return on her savings.
Mr. Mastracci suggests she take an active interest in her portfolio. At present, she does not know what mutual funds or other assets are in her RRSPs.
?What makes this case salvageable is Edna?s high current rate of savings,? Mr. Mastracci says. ?She has nine years to go to her planned retirement and there is a likelihood of salary increases in the meantime. She has ample time to get her finances in order. Whether she does it is, of course, a question of motivation.?
Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis.
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