Hey there, time traveller!
This article was published 17/1/2014 (1193 days ago), so information in it may no longer be current.
Jim and Melba recently bought their retirement dream home. The problem is they're worried it might turn out to be a financial nightmare.
Recently remarried, they bought the $700,000 sprawling two-storey house in a new development, owing about $264,000 on the mortgage.
While they thoroughly enjoy their new love nest, they are somewhat uncomfortable carrying debt into retirement.
Melba, 59, is already retired. She draws an income of about $3,900 a month from a CPP survivor's pension, an annuity from a life insurance death benefit and her investments.
Jim, 65, is a semi-retired entrepreneur who recently sold two-thirds of his business for about $500,000. He still works part time at his business, drawing a salary of about $85,000 a year. Although he also collects about $925 a month from CPP, he is delaying collecting OAS until age 70, when he plans to fully retire.
He'd like to retire sooner, but without a work pension, he worries about burning through his savings, especially while paying more than $1,200 a month on the mortgage
"If you could tell me I would be able to afford it, I would retire tomorrow," he says. "In all seriousness, though, I think I would be involved in the business somewhat, but I'd like to know if I felt too tired to work that I could actually retire."
With more than $1.3 million in investments and cash, the couple could pay off the mortgage outright, but they worry about the taxes they'd have to pay when withdrawing a large lump sum from their investments to cover the cost.
They also believe they can afford the payments even when Jim fully retires. Still, they worry about the long-term picture.
"Right now, our interest rate on our mortgage is very low, but if the interest rate shoots up a fair bit, that's worrisome," Melba says.
They're also concerned that having debt later in life will affect their ability to move should they need a more age-suitable place to live.
"My question is, in the later years, will we have enough money to sell the house and move to a nice place?" she says.
Lyle Atkins, a Winnipeg for-fee certified financial planner, says Jim and Melba could choose either path -- carry the mortgage or pay it off -- and still make out all right because they have considerable financial assets.
More than anything, what they choose to do will boil down to what lets them sleep best at night.
"It is a personal issue, and carrying a mortgage can really bother some people," says the planner, with Independent Financial Counsellors.
The couple certainly has enough money to pay the mortgage off tomorrow and still draw enough income from their investments to support their lifestyle -- if they choose that route.
But Atkins says paying the mortgage in full immediately does have its downsides. For one, it limits the flexibility of the finances.
"Many people spend a lot of money paying off their homes prior to retirement and then once they are retired, realize that they have a lot of cash tied up in the home, so they go out and purchase a reverse mortgage or run up a line of credit for travel and other needs," he says.
While it's unlikely they'd need to borrow to support their lifestyle, Jim and Melba may still want to take a wait-and-see approach to whether or not to carry the mortgage once Jim retires. This way, if interest rates rise, significantly increasing their payments, they can pay the mortgage off at any time.
If they go down this path, they should set aside the capital they would use to pay the principal owing, investing in a conservative portfolio of fixed-income and cash.
"It would earn slightly less than the rate they are paying on the mortgage, but doing this allows them the flexibility to use the money for other needs and to know that the money is there if they do want to pay it off."
Regardless of what they choose to do, the numbers indicate they will still enjoy a comfortable retirement, even if Jim retired tomorrow.
Here's roughly how the numbers play out in both scenarios. The couple needs about $73,000 a year for expenses, which means they require about $97,000 a year of income before taxes.
"If they keep the mortgage, Melba should be able to create a sustainable income of about $47,000 and Jim should be able to create an income of at least $75,000 even if he retires now," Atkins says.
With a pre-tax annual income of about $122,000, they'd have more than enough to pay for the mortgage.
But if they pay off the mortgage now, Melba's income would drop to about $40,000 a year and Jim's would decrease to about $67,000 -- which still exceeds their retirement-income needs.
These estimates are based on two per cent annual inflation and six per cent market returns to age 90 for both, so they may have to adjust their plan as they go along to make sure their retirement spending doesn't exceed their financial resources if the aforementioned assumptions prove incorrect.
Still, they should have enough breathing room in their budget and savings to absorb most shocks.
Furthermore, Atkins says they shouldn't be overly concerned about the cost of enhanced retirement living options as they age.
Even if they have a mortgage well into retirement, they would have enough equity in the home to cover the cost of an assisted-living residence that suits their lifestyle.
"Living in these facilities seems expensive, but once they are in these facilities, their other income needs are likely to be very little, and a good part of the nursing home costs are tax-deductible."
The fact is, with more than $1 million in assets, Atkins says Melba and Jim are in good financial shape -- mortgage or no mortgage -- so they can go ahead and enjoy their dream home without worrying about the nightmare scenarios that keep them up at night.