Early retirement goals come with trade-offs

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Leif and Sam.

Kim Jay / The Globe and Mail

It has been said that people start looking for a work-life balance in their mid-forties, and the same goes with Leif and Sam. Leif, who works in education, is 46 years old. Sam, who works for a non-governmental organization, is 47 years old. Together they earn $ 255,000 per year.

Leif and Sam have a 6-year-old daughter to put to school and a big mortgage to pay off their house in British Columbia before they retire. Leif will receive a work pension of $ 61,000 per year at age 60, indexation will depend on the plan’s ability to pay. Sam does not have a pension plan.

“We are in a fairly common and confusing situation as recent owners of [one of] Canada’s hottest real estate markets, ”Leif wrote in an email. “It’s important for us to balance being too focused on saving for the future and enjoying our present life, with travel and adventure,” he writes.

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“Does it make more sense to save money or pay off the mortgage?” “

They would like to retire in 15 years, ideally with their house paid off and a retirement income of $ 96,000 per year after tax, he adds. “Can we do it?” They are considering shortening the mortgage amortization when it renews this spring. Finally, “How can we find investments with reasonable returns, low carbon, and socially and environmentally responsible – and which do not involve the purchase of individual stocks?” “

We interviewed Ngoc Day, a financial planner at Macdonald, Shymko & Co. Ltd. in Vancouver. Macdonald Shymko is a fee-only financial planning firm. Ms. Day holds both the Chartered Financial Planner and Chartered Financial Planner designations.

What the expert says

Leif and Sam spend $ 119,300 per year, including mortgage payments, but excluding income taxes, payroll deductions and her pension contributions, Ms. Day said. They contribute $ 2,400 per year to their child’s registered education savings plan and $ 19,200 per year to their tax-free savings account. They have an additional savings capacity of $ 34,800 per year.

In preparing her forecast, Ms. Day assumes an inflation rate of 2% and an average annual rate of return on investments of 5%. The life expectancy is 95 years. To be on the safe side, the planner assumes that there is no indexation of Leif’s annuity. “Any indexation provided will be an added bonus to their retirement income. “

First, the planner compares the investment of his savings and the mortgage payment. At Leif’s 40.7% marginal tax rate, saving 2.64% on mortgage interest is equivalent to earning a 4.45% rate of return on an unregistered account, according to the planner. If they were to invest their savings in their tax-free savings accounts, in order for their return on their investment to outweigh the savings mortgage interest, they would have to take some market risk, she says.

An “apples to apples” comparison would be the guaranteed savings on mortgage interest of 2.64 percent compared to five-year guaranteed investment certificates – with a principal guarantee and no volatility – yielding 1.8 percent. . “Overall, it makes sense to speed up their mortgage repayment,” Ms. Day says.

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“That being said, they could improve their overall tax efficiency by doing both: invest their savings in their RRSPs, then use the tax refund to pay off the mortgage.

Leif would save $ 40 for every $ 100 he contributes to his RRSP, the planner notes. For Sam, the RRSP tax savings would be around 32 percent. “Therefore, the priority is first to maximize Leif’s RRSP.

The invested capital will grow tax-free in her RRSP for many years to come, says Day. “By using this two-pronged approach, they would build up their retirement savings, save income tax and reduce their debt load.

Sam and Leif plan to shorten their amortization period when the mortgage needs to be renewed in hopes of paying it off before they retire. They could get the same thing by making lump sum payments on their mortgage, according to the planner. The mortgage principal would be reduced quickly and interest charges over the life of the mortgage would be minimized. Making lump sum payments would also give them more flexibility in the event of unforeseen expenses.

Next, the planner examines the couple’s goals to retire at age 60, mortgage-free, with after-tax expenses of $ 96,000 per year. In this, they face trade-offs, she said. “This couple has a lot of debt and a good income, but they have to decide whether they are going to enjoy life now or retire early.”

Although Leif’s DB pension entitlements provide a solid foundation for their retirement income, based on the above assumptions, retiring at age 60 with after-tax income of $ 96,000 will be a challenge, says Ms. Day . “They may run out of savings around the age of 73.” At this point, they would need to downsize their home to free up capital for retirement expenses.

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An alternative is to work longer. If Leif and Sam are willing to work until age 65, they would improve their retirement outcomes because they would have more high-income years to pay off debts, build their RRSPs, and increase pension entitlements. Leif’s PD, the planner said.

Another alternative is to cut some discretionary spending right now – for example, their travel budget of $ 24,000 a year – and use the savings to pay off the mortgage, she adds. “By speeding up mortgage payments, they could dramatically reduce the mortgage amount within 60 years and could potentially meet their goal of retiring at age 60 with little debt.”

Next, the planner reviews the couple’s investments, which are in a number of socially responsible mutual funds at their financial institution.

“I would suggest that Leif and Sam consider a two-step process in their investment planning,” says Ms. Day. First, they need to determine the appropriate asset allocation targets for their entire portfolio – for fixed income, equities and real estate investment trusts, all geographically diverse. “Asset allocation targets need to be tailored to their combined risk profile,” says the planner. The goals serve as the basis on which all future investment purchases or rebalancing activities will be designed, ”she said. “It will help build discipline in their investing process and help them avoid chasing after the hottest and newest favorites.”

Once asset allocation goals are set, they could use environmental, social, and governance (ESG) focused exchange traded funds to align with both their desired goals and life values. , rebalancing if necessary to keep allocations within the target range.

While their current portfolio holds mutual funds with socially responsible investment mandates, it is not clear whether there is an overall asset allocation target for all accounts, or whether there are any rebalancing strategies. are in place, says Day. Additionally, mutual funds tend to have higher management expense ratios than ETFs. “A wide selection of ESG-focused ETFs are available to offer both diversification and low costs,” says the planner.

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Client situation

The people: Leif, 46, Sam, 47, and their daughter, 6

The problem: How to find a balance between enjoying life now and saving for retirement. Find socially responsible investments that don’t disappoint.

The plan: Contribute to their RRSPs and use tax refunds to pay off the mortgage. Consider working longer or reducing your current expenses. Set asset allocation targets based on the risk profile and switch to socially responsible ETFs.

The reward : A better idea of ​​the trade-offs required when trying to achieve a lifestyle balance.

Monthly net income: $ 15,285

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Assets: $ 56,770 in cash; house $ 866,700; his RRSP $ 105,440; his RRSP $ 88,120; his TFSA $ 14,370; his TFSA $ 12,035; RESP $ 22,665; estimated value of his DB pension $ 504,000. Total: $ 1.67 million

Monthly expenses: Mortgage $ 2,150; property tax $ 350; home insurance $ 140; utilities $ 280; transportation $ 240; groceries $ 1,200; child care $ 275; clothing $ 100; gifts, charity $ 300; vacation, travel $ 2,000; meals, drinks, entertainment $ 800; personal care $ 50; sports, recreation $ 300; health, dental insurance $ 820; life insurance $ 165; disability insurance $ 270; doctors, dentists $ 200; telephones, television, Internet $ 300; RESP $ 200; TFSA $ 1,600; his contributions to the pension plan $ 645. Total: $ 12,385

Liabilities: Mortgage loan $ 540,000

Fancy a free financial facelift? E-mail finfacelift@gmail.com.

Some details can be changed to protect the privacy of those profiled.

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