Freedom 70

Opinion

Hey there, time traveller!
This article was published 11/09/2010 (5494 days ago), so information in it may no longer be current.

Malcolm and John refer to themselves as "late-blooming artsy types" with regard to their careers. John, in his mid-40s, is a freelance writer scratching out a living on $32,000 a year, before taxes.

Malcolm, in his early 50s, is a university professor, earning about $73,000 gross a year.

Only in the last few years has the couple been able to find firm financial footing, thanks in large part to Malcolm’s full-time position.

While most people dream of ‘freedom 55,’ John says they are only now starting the second phase of their careers. Gone are the days of living hand-to-mouth — the proverbial starving artists suffering for their art.

 

They foresee the next two decades as being the most productive of their lives. Early retirement is out of the question.

They imagine stopping full-time wage slavery at age 70, perhaps working only a few contract jobs.

"I’d like to travel the world, but Malcolm is more of a warm weather kind of guy," says John, imagining taking four or five months of vacation time per year after they retire.

Standing in their way of ‘freedom 70’, however, is a pile of debt and a dearth of savings. Malcolm has a defined benefit pension, but they only have a little less than $10,000 combined in RRSPs, non-registered and a Tax-Free Savings Account (TFSA), which is for emergencies.

"I realized because he had a work pension that I needed to come up with something in my name for retirement," says John, who contributes $1,500 a year to his plan, while Malcolm contributes $500 to his.

Their debt, in contrast, is substantial. John has a $25,000 student loan he’s in no hurry to pay down because the interest is tax deductible. They also have a $9,000 credit card balance at 1.99 per cent for the next 13 months. It’s a transfer from another balance. They are paying $1,150 a month on the balance.

They also have a mortgage of $139,000 on a home worth $187,000, recently appraised after they rolled a $15,000 debt into the mortgage.

While they want to be debt-free by retirement, they face a dilemma about how best to work toward their goal.

"The money we have available to us over and above our budget is pretty much split between the two priorities," John says. "What’s the balance between paying down debt and saving for retirement?"

Certified financial planner Bob Challis says the couple should focus on reducing debt. In the long run, this will free up future cash flows, which can then be invested.

The first debt to pay down is the credit card balance, even though it has the lowest interest rate for the time being. At their current payment rate, it will be retired in less than nine months.

"I suggest the cash flow freed up in the 10th month be applied directly to the student loan of $25,000," says the planner with Nakamun Financial Group in Winnipeg. "Even though the interest on the student loan is deducted from income, it is still a cost to cash flow."

At the current pace of paying only $300 a month, the loan will linger on for at least nine more years.

"By paying off the credit card, then student loans, these two will have over $13,000 a year, beginning less than three years from now, to apply against the house mortgage or to invest."

In the meantime, they can also restructure their investment strategy.

Challis says it makes little sense for John to contribute to his own RRSP.

"The tax relief gained is nominal at best because he pays so little income tax," he says. "They would be vastly better off if he gave the money to Malcolm, who in turn deposits it to a spousal RRSP in John’s name."

Every dollar John gives to Malcolm to contribute to the spousal plan would save Malcolm — earning the higher income — at least 39 cents of tax payable.

"Even though Malcolm has a pension plan, he should be contributing the maximum possible into the spousal RRSP for John," Challis says. "This will gain maximum tax relief and allow some income-splitting when the funds are turned into taxable income."

At this point, they shouldn’t have a TFSA. That money — as well as the money in their non-registered account — would best be applied to debt repayment.

"Later, when the debts are repaid and the RRSPs are building nicely, extra cash flow can be put towards TFSA," he says. "The available contribution room is never lost; it just accumulates and carries forward."

For emergencies, they still have some equity available in their home and they should arrange for a $10,000 line of credit to be used only when absolutely necessary.

Challis says Malcolm and John have more than enough to be debt-free by the time Malcolm reaches age 70, as long as they don’t accumulate more debt.

In fact, they can be entirely debt-free before the end of the decade if, after paying off the student loan and credit card debt, they put those payments against the mortgage.

"If interest rates remain similar to what they are today, and the monthly repayments remain at the current level of $2,381 a month, we calculate they can be debt-free in less than seven years — even sooner if they also redirect their savings flow to debt," he says.

If they were to divert monthly payments to their registered savings over the next few years to debt, they would be debt-free in about 51/2 years. This would also save them about $23,000 in interest payments.

At that juncture, they can invest in the spousal RRSP. Any money in excess of the contribution limit can be invested in the TFSA.

"Earning an average of annual return of just five per cent, they will have accumulated somewhere around $577,000 in savings in about 111/2 years," he says.

That would provide them with about $70,000 in pre-tax income by the time Malcolm reaches 70.

"With this amount, combined with CPP, OAS, Malcolm’s pension and their freelance income, travelling exotic locales will be possible," Challis says, emphasizing their success will depend on their ability to set an accurate budget and stick to it.

"But (travelling) for four to five months a year, while keeping up the expenses at home, may be a stretch."

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