Pay yourself first to achieve early retirement Money Makeover

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These days, however, few people likely believe it's attainable, particularly with last year's stock-market crash.

But Sharon and Wayne, both in their early 50s, still have their sights set on early retirement five years from now.

And if that doesn't sound ambitious enough, they'd like to spend about one-third of their retired lives soaking up the sun down south or sipping wine in Italy.

"In the first year of retirement, we are looking to go to Mexico for three to four months," says Sharon, an executive director of a charity who earns $75,000 annually.

"Maybe the next year, we'll go to Italy and teach English for a couple of hours a day for free rent," says Wayne, a teacher earning $77,000.

While their goal to travel about four months of every year is ambitious, Sharon says they plan to do it as frugally as possible.

"We'll go to a small Mexican town where we can rent month-to-month where we do our own cooking," says Sharon, who also has an education degree.

"We want to enjoy the warm weather and get involved in the little town, sort of community activities."

But they're concerned whether the economic reality of their finances will actually match their retirement vision. Wayne will receive about $2,500 a month gross in pension payments upon early retirement. And Sharon has close to $190,000 in retirement savings. They expect they will need $4,000 net combined each month in retirement, but they're worried whether they'll have that much. And even if they do, they're not sure that will be enough.

"We both make about $8,000 a month, net, and we're just zeroing out at the end of the month," she says.

While she is thrifty with her spending, she says they suffer from "leakage" spending.

"I do like to impulse-buy," Wayne admits, adding he recently purchased a graphite hockey stick on a whim.

The new stick did come in handy, as he scored four goals in a game later that day. But are those free-spending habits putting them offside of their retirement dream?

At their income levels, Sharon and Wayne should easily make the transition from worker drones to snowbirds in early retirement, says chartered accountant and certified financial planner James Kraemer.

But the fact they are spending so much today could pose problems in the future. They need a budget that works, but rather than coming up with a detailed list of expenses right down to the nearest penny, Kraemer recommends a technique from the popular financial advice book The Wealthy Barber.

"A concept that would do them very well is the idea of paying yourself first," says Kraemer, vice-president of Winnipeg-based TFI Financial Services.

"If they take care of all their major expenses -- debt retirement, automobile expenses, retirement saving -- it doesn't matter how much they spend on entertainment, hockey equipment, gifts or anything else, because they've already paid themselves first, making sure they are going to accomplish their plan by saving enough money."

Kraemer says, based on their incomes, they should have enough money to maximize their RRSP and tax-free savings account contributions.

While they may have limited contribution room for RRSPs, Kraemer says maximizing the registered savings will provide tax efficiency both today and in the future.

"Right now, their tax rates are about 39.4 per cent (on average)," he says. Five years from now, taxes on their combined income would be much less in order to achieve their goal of $4,000 net every month.

"That's $48,000 net between the two of them a year or $24,000 each, which would mean they would have a gross of about $33,000 each."

The tax rate on that income would be 27.75 per cent.

"They're going to save 12 per cent in taxes just by saving the money now and paying a 12-per-cent less rate in the future."

Equally important is the TFSA. Kraemer says if they maximized their TFSAs for the next five years, they would at least have $50,000 in non-taxable income (both contributing $5,000 each yearly).

"That's money that they can use to bridge their 55 to 60 years," he says, adding after 60, they can draw the Canada Pension Plan, albeit at a reduced rate.

Those additional registered savings would easily top up Wayne's pension income to the required $33,000.

But Sharon has a defined contribution plan that will pay much less, so those additional registered savings would offer her more flexibility to achieve the same income as Wayne.

One other suggestion Kraemer says they might consider is using their credit card for monthly expenses, such as gasoline, utilities, insurance and groceries. Most cards accumulate points towards flights, which would be ideal for this couple, he says.

"They can't put certain expense on their credit card, but there are a lot -- groceries, gas and auto repairs -- that will add up," he says. "You have to be disciplined, though, because as soon as you miss a month, you get dinged with a 19-per-cent interest rate."

But while earning a few extra Air Miles for vacations may help cover a sliver of costs to live their retirement dreams, Kraemer says it all comes down to how they want to match their plans with reality.

"Judging from their numbers they have presented, it's hard to say if they can actually live within their retirement budget," he says, believing the figures are too low. "It's easy to put some numbers onto paper, but when the rubber hits the road, what are their spending habits?"

Their expenses in retirement should be less much less than today, considering they will not be paying a mortgage, which frees up $900 a month, but their ability to deal with fluctuating costs in retirement comes down to their commitment to saving today.

If they "pay themselves first," Kraemer says, Wayne and Sharon can take those yearly vacations -- and even buy a couple of graphite hockey sticks.

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Wayne and Sharon's finances

Income:

Sharon: $1,978, net, every two weeks

Wayne: $2,028.80, net, twice monthly

Total monthly net income: $8,343

Investments:

Sharon

TFSA: $1,879

Non-locked-in RRSP: $106,066

Locked-in RRSP: $41,158

Estimated work pension: $40,000 to date

Sharon's total registered savings: $189,103

Wayne

TFSA: $1,464

RRSP: $6,896

Pension payment to last survivor from TRAF, starting Feb. 2014: $2,544 gross per month. (Kraemer estimates this would be the equivalent $600,000 in RRSP savings.)

Wayne's total estimated retirement savings: $607,042

Expenses:

Mortgage (two per cent) and line of credit (2.5 per cent) combined: $54,000; paying $450 every two weeks; estimated home value: $300,000. (Mortgage and line of credit will be paid off by retirement date in 2014.)

Monthly fixed expenses, including mortgage payments, utilities and gasoline: $2,410

Projected future monthly retirement budget:

Expenses, including travel costs: $2,537

Desired net income: $4,000

Republished from the Winnipeg Free Press print edition November 28, 2009 B19