Right-sizing for retirement

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John and Candy hope moving out of their $600,000 home into a $460,000 condo will allow them to enjoy an early retirement and the snowbird lifestyle their parents live. (BORIS MINKEVICH / WINNIPEG FREE PRESS) Photo Store

John and Candy want to follow in their parents' retirement footsteps. The couple wants to retire at 60 and spend winters in Arizona, on a budget, living in a resort trailer park.

"Both our parents were snowbirds and we visited quite often and we really liked the lifestyle," says John, 55, who works in sales, earning $63,000 a year, plus bonuses.

"That's our dream, but we're not sure it's going to happen."

Part of the problem is John will have no pension. Candy, age 52, earns about $40,000 a year and is a member of a defined-benefit plan -- one of the few remaining pensions of its kind in the private sector -- and she expects a monthly pension of about $907.

They also have about $300,000 in retirement savings.

While they hope to save much more by the time they retire, they also are weighed down paying off a mortgage on their $600,000 home, on which they owe $385,000.

But they have a plan: They're going to downsize, moving to a condo priced at $460,000.

They've already made a $47,000 deposit on the condo, money they had to borrow on a line of credit, and they expect to move in two years when construction is complete.

They expect to have a $250,000 mortgage, and they're wondering how quickly they can pay it off so they're not burdened by debt for long in retirement. John says they don't spend much money on entertainment or other discretionary expenses because, as only children on both sides, they spend much of their free time taking care of their aging parents who are both in poor health. At some point, they expect a transfer of wealth, but they do not want to rely on an inheritance to reach their financial goal.

Yet they know their plan will be challenging, and they know they need guidance.

"What will that look like for us financially and is it realistic?" Candy says.

Jan Fraser, a certified financial planner, says it's admirable John and Candy want to eliminate their debt as soon as possible, but a hurry-up approach to paying off the mortgage will severely restrict their cash flow early in retirement. Even today, their debt costs put a lot of pressure on their finances.

"They're putting a huge whack of money every month against debt," says the adviser with Fraser and Partners in Winnipeg.

Their mortgage payment is $2,640 a month. While they may have more cash flow in their budget when they downsize, Fraser says money will still be tight, especially early in retirement. As a result, they will have a tough time spending five months in Arizona, paying rent there while carrying a big mortgage here in Winnipeg, and maintaining the lifestyle they're accustomed to today.

Fraser estimates Candy and John would quickly burn through their savings, leaving them in a position in their mid-70s with their condo paid for, yet ironically, they'd likely have to downsize or borrow against it to maintain some semblance of the lifestyle they hope to enjoy.

As an alternative, they should consider investing any proceeds from the sale of their current home, and taking a much longer time to pay off their mortgage. Since they already have made a down payment -- the condo deposit -- they'd have a mortgage of about $405,000, leaving them with about $126,000 to invest.

"It sounds like blasphemy because everybody is so focused on getting rid of their debt," she says. "But this way they can have a little bit more fun in the early years."

Fraser says this strategy hinges on one important condition: When they receive an inheritance, they must use it to pay off their debt.

This is important because although interest rates are low today, they likely won't be in 10 years and rising rates will threaten their retirement by diverting more of their cash flow toward debt. Stretching out the amortization on their mortgage is really the only way for them to be able to have enough cash flow early in retirement to enjoy time in the sun.

Based on three per cent inflation and a five per cent return on their investments, they would still be drawing heavily on their capital to cover expenses. Their net income would also fluctuate from about $31,000 net for John early in retirement to a little more than $51,000 combined -- in today's dollars -- in mid-retirement when they're both receiving old age security.

But again, they'd often be in a position where expenses would outstrip their pension money, forcing them to draw down capital, which would put them back in a similar position -- using their condo as a source of income or dramatically cutting back their lifestyle, only a little bit later than in their original plan.

Fraser says they do have another option. John can work a few years longer, waiting until Candy turns 60. In this instance, their net income increases in today's dollars to a minimum of about $42,000 early in retirement to a maximum of $66,000-plus in mid-retirement. Still, their income would gradually decline from their mid-70s to about $27,000 (in today's dollars) in their 90s.

By their mid-80s, they may still have to consider downsizing. At least, they'd have much more income earlier in retirement for travel.

"By taking a longer time paying off debt, they're going to have more cash flow early on when they're more likely to be adventurous, but it's still going to be a challenge," Fraser says.

"Yet, I am only suggesting they take on this much debt and stretch it out that long to achieve their goals because they're going to receive a transfer of wealth that will help them eliminate it at some point down the road."

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John's and Candy's Income:

John: $63,000 ($4,015); received $12,000 bonus in 2011

Candy: $40,965 ($2,383)

ñü MONTHLY EXPENSES: $6,126

ñü DEBTS:

Mortgage: $385,357 owing at 4.31 per cent

Line of credit: $47,000 owing at 4 per cent

Car loan: $21,000 owing at 4.5 per cent

Total: $453,357

ñü ASSETS:

Home: $600,000

John RRSP: $83,863

John LIRA: $88,695

Candy spousal RRSP: $88,233

Candy RRSP: $28,746

Candy work pension: $907.50 at age 60

Joint saving: $4,250

Total: $894,619

ñü NET WORTH: $441,262

Republished from the Winnipeg Free Press print edition November 10, 2012 B11