Retirement is Coming and We Don’t Have Any Savings
Many Canadians have a reasonable degree of net worth. Millionaire households are not that unusual if you consider the value of housing, especially if you have been a homeowner for 20 years or more, which would be the case for many who are approaching retirement. More than likely, your mortgage has been paid off or nearly so. But, if you have bought in a more expensive area or later in life such that you have been barely able to save anything, you may find yourself “behind the eight ball.”
If you are lucky, your employer has established a mandatory pension plan or group RRSP. That way you have been forced to save at least something. If not, the day-to-day demands of living may mean that you have little to no savings.
For today’s post, let’s imagine a couple, John and Jane, who were both born in 1964, the last year of the baby boom cohort. That puts them at age 58 as of 2022. Between the two of them, they earn gross incomes of about $120,000 and spend about $90,000 per year on an after-tax basis. Both are on track to receive the average Canada Pension Plan (CPP) payment at age 65, $727.61 per month in 2022. As lifelong residents of Canada, they are both eligible to receive the maximum Old Age Security (OAS) at age 65, currently $685.50 per month in the last quarter of 2022.
Their Retirement Assets
However, they have never worked in jobs that have provided pension plans. Although they had never missed a mortgage payment, they have never been great savers, either. Ten years ago, they went to their local bank branch and opened Registered Retirement Savings Plans (RRSPs). They began by putting $100 per month into each of their accounts, which they have kept up to this day, investing in the same global balanced mutual fund, which on average has returned about 4.5% per year. Each spouse now has about $15,000 in their respective RRSPs.
They paid off their mortgage a month ago and decided that this is the time they have to start catching up on their savings for retirement. Their mortgage had been $800 per month, so they split it in half, increasing their monthly RRSP contributions to $500 per month each. Fortunately, they have no other debts, and they pay off their credit cards in full each month.
Their Retirement Goal
The “standard” age of retirement in Canada is 65. This is reflected in how CPP payments are calculated as well as the age at which one becomes eligible to receive OAS. This couple agrees that 65 is a reasonable retirement age for them. However, they wonder how much their RRSPs will be worth by that time, and whether they will be able to sustain a reasonable lifestyle for the rest of their lives, which they estimate could be another 40 years, to age 98, for at least one of them.
Scenario 1: Retire at 65; Maximum Sustainable Spending; House Not Sold
This is the scenario that this couple agrees is their ideal. However, it does not leave them with a lot of room for spending in retirement. They retire partway through 2029, the year when they each turn 65. Between the two of them, their RRSPs grow to about $125,000. In their first full year of retirement, in 2030, they have the following incomes.
These figures will grow with inflation, but they cover only about 51% of their current after-tax spending in nominal terms or about 43% in real or inflation-adjusted terms ($45,520 in 2030 is equivalent to $38,547 in 2022).
Other scenarios will involve delaying CPP and OAS, so a summary of the year 2035 is also presented.
Scenario 2: Retire at 65; Maximum Sustainable Spending; House Sold
Jane and John, not thrilled with the dramatic decrease in income in retirement, consider the idea of selling their house. For this scenario, they sell it in 2032 for the inflation-adjusted equivalent of its $500,000 value today, approximately $620,000. They move these proceeds into their respective RRSPs because they still had contribution room and were under age 71, the year when they would have to convert all RRSPs into Registered Retirement Investment Funds (RRIFs). In addition, they contribute to Tax-Free Savings Accounts (TFSAs) and non-registered accounts. All accounts are invested in the global balanced mutual fund.
This decision allows them to increase their spending throughout their retirement from $38,547 to $57,528 in real terms. In 2035, their nominal income details work out as follows:
You may wonder how greater income can lead to lower taxes. The answer lies in the decision not to withdraw from the RRSP this year. Note that this would not be possible if any portion of John or Jane’s RRSPs had already been converted to RRIFs. In that case, a withdrawal would be mandatory. Leaving the funds in RRSPs, which they can do because they are still below age 71, allows them this flexibility.
The withdrawal from a non-registered account in itself does not trigger a tax obligation. Rather, taxes are triggered from interest paid on fixed-income assets, dividends paid from certain equities, and/or capital gains made on the securities that were disposed of in that year.
Is this a better outcome? Previously, Jane and John had a house. Maintenance of housing has its costs but without a mortgage, the overall cost may be less than renting a home. The question that needs to be answered is whether there is sufficient gain in income to outweigh any extra costs associated with renting. This can vary depending on where John and Jane live.
Scenario 3: Retire at 70; Maximum Sustainable Spending; House Not Sold; Investments Improved
Jane and John are happier about the income outcome if they sell their house, but they wonder if there is another way to increase their income. They reluctantly consider the idea of extending their working years to age 70, which would also allow them to keep on contributing to their RRSPs, and delay starting CPP and OAS, thereby increasing the amount of guaranteed, inflation-adjusted income. In addition, they review their investments and find that they can reduce their fees, increasing their average return from 4.50% to 4.83%.
You may notice the significant difference between the amounts that John and Jane withdraw from their registered accounts. This is largely due to the previous year’s withdrawals when they began retirement. In this series, Jane is six months older than John, so she retires and begins drawing from her RRIF income a half-year sooner. To even out their long-term annual spending more is drawn from John’s account than from Jane’s.
Nevertheless, the tax impact of this larger withdrawal is minimized because of the ability to split pensions, which a RRIF is considered to be once the annuitant (the holder of the RRIF) has reached age 65.
Scenario 4: Retire at 65; Maximum Sustainable Spending; House Not Sold; Invest More and Better
In Scenario 1, Jane and John committed to increasing their contributions to their RRSPs to $6,000 per year each. That is about 10% of their annual earned income. But what if they contributed their annual maximum of 18% of earned income, excluding any contribution room that they had built up over their earlier years? That means contributions in the $11,000 range for each of them, each year. Doing so would increase their respective RRSP balances at retirement from a little over $62,000 each to about $100,000.
While doing so would “train” Jane and John to live on less because they were saving more, the difference was meaningful but not sufficient. Their after-tax real spending increased from $38,547 to $41,395. In nominal terms the figures worked out as follows:
While saving more certainly makes a difference in this scenario compared to scenario 1, the greater difference comes from selling the house or delaying retirement.
Which do you prefer?
To quote the Rolling Stones, “You can’t always get what you want.” Retiring at 65 and keeping the house resulted in an unacceptably low retirement income for Jane and John. Selling their house and renting increased their income, allowing them to retire at 65, but the cost of renting versus owning a home needs to be taken into consideration. An advantage in one city may be a disadvantage in another.
If selling the house is beyond consideration, then one of the better alternatives is to keep working to age 70 (or beyond). The increase in payments from CPP and OAS combined with the larger balance in John and Jane’s registered plans, plus the fewer years in retirement that need to be funded, added together to create a significant improvement in income. Not everyone wants to keep on working past 65 and physically sometimes it may not be possible, but given the general increased longevity in our society, this is an alternative that more Canadians will need to consider.
What about Scenario 4, where the main approach was to scrimp and save more in their RRSPs? While it did some good, with only 7 years until retirement, the extra savings, and the opportunity to grow the accounts through compounding just were not up to the task.
I suppose there is an alternative to all of these. Jane and John, being at the tail end of the baby boom, may still be expecting an inheritance from their parents. A survey from 2016 found that the average inheritance received in the previous decade for those between 50 to 75 was about $180,000. If each spouse were to receive that amount, that would be an extra $360,000 in assets. The problem is, we generally cannot count on an inheritance, and even if we can, we cannot count on when it will be received and how much it will be. We would do well to discount this possibility.
Our saving and investing history may make the future financially challenging. However, there is nothing that says we cannot make changes going forward. The habits we may have established will be hard to reform, but a plan to do so is the first step toward a brighter future.
*Results calculated with Snap Projections
This is the 172nd blog post for Russ Writes, first published on 2022-11-14.
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.
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