07Situation: Man hopes good salary, conservative spending and careful investing support retirement at 45

Solution: Even with aggressive savings and low mortgage rate, 60 is a more realistic goal

In Quebec, a man we’ll call Michel, 34, works in financial services. He earns $70,000 a year and takes home $3,640 per month after many deductions for taxes and benefits. Frugal in his spending, cautious in his investing, he wants to retire at age 45 with $40,000 income per year after tax. Assuming a 3 per cent return rate after inflation, that implies he will be able to add $1 million to present savings in 11 years. On present income, it’s unlikely.

Michel’s goal is to quit his niche in the numbers business and travel the world. The problem is how best to finance the years before he is eligible to receive benefits from the Quebec Pension Plan or Old Age Security. In the case of the former, it will be at least 26 years until he can access QPP (albeit with a 36 per cent discount to the normal age 65 amount) and 31 years until OAS kicks in at 65.

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His plan is to fill the gap with outflows from his RRSP or TFSA accounts. His strategy is to save very aggressively, but his plan is based on not spending rather than on making a big score in investments. That is conservative and reasonable, indeed it is the best way to proceed. But the question remains how to save as much and as fast as he reasonably can.

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“Should I accelerate my mortgage payments, and, once it is discharged, invest in the stock market or should I make scheduled mortgage payments and invest what I can now?” he asks. “If I invest heavily and can attain a base for $40,000 annual withdrawals, can I bridge the time until 65 when I can draw on CPP and receive OAS? “

Debt management and investment returns

There are a lot of variables in this ambitious plan. Michel asked Family Finance to run the numbers to test its feasibility and, as well, how to achieve his spending goal with the lowest tax cost along the way. The problem of early retirement is twofold: Not only must one build up savings faster, but those savings have to last a longer time than they would with later retirement.

Family Finance asked Caroline Nalbantoglu, head of CNal Financial Inc. in Montreal, to work with Michel. “He is a disciplined saver and, at 34, he has a condo with an estimated value of $165,000, $115,030 in RRSP and TFSA accounts and just one debt — a $97,000 mortgage with 24 years remaining amortization. At present rates, the mortgage will be paid when Michel is 58. For a relatively young person, it’s a picture of a very solid financial base,” she says.

Accelerated pre-payment of the mortgage at the expense of investments is not necessarily a good idea. His present interest rate, 2.9 per cent, has to be paid with after-tax dollars, so in his bracket the real cost is about 3.4 per cent. He can beat that with dividends from shares in chartered banks whose shares yield 3.5 per cent to 4.5 per cent plus or minus capital appreciation/depreciation or shares of utility stocks that have 4 per cent to 5 per cent dividend yields before share price changes. Rising interest rates may tip the balance toward accelerated mortgage payments, but Michel needs all the money he can save and invest for his goal of early retirement. However, if mortgage interest rates rise a couple of per cent, then he can accelerate his mortgage payments, the planner says.

Timing retirement

Michel’s goals will be hard to achieve even by 50, the planner says. The earliest he can retire with a $40,000 income after tax is 60. Assuming that he can achieve and maintain a 3 per cent annual return after inflation, then in 26 years his RRSP with a present value of $90,701 and $10,800 annual contributions will have risen to a value of $612,000. With the same assumptions, his TFSA with a present value of $24,329 and $6,000 annual contributions including catch-up additions to fill space will have risen to a value of $283,800. His total capital available for retirement income will total $895,800.

Assuming a 3 per cent return before tax, his RRSP and TFSA capital at 60 would generate $40,475 per year based on an annuitized payout that would exhaust all capital and income in the following 35 years to his age 95.

If he were to draw QPP of 64 per cent of a theoretical maximum benefit of $13,600 in 2019 dollars per year at age 65, $8,704, his total income would be $49,179. Retiring early makes attaining this maximum unlikely even with scheduled increases in CPP/QPP contributions and benefits, a planned 52 per cent boost to be phased in starting Jan. 1, 2019. After 20 per cent average tax, he would have $39,343 per year or $3,280 per month. At age 65, he could add Old Age Security benefits, currently $7,210 per year for total income of $56,389 before tax. Still using the 20 per cent rate, he would have post-tax income of $3,760 per month.

His expenses with no mortgage payments nor savings would be about $2,000 per month. If we add $1,000 per month for travel, his expenses would be $3,000 per month. There would be $760 for other expenses, such as a newer car or expanded clothing budget, which currently stands at just $50 per month.

The end game

Our calculations show that even if Michel retires at age 60, 26 years from now, he would have to live very modestly. Retiring at 60 and starting QPP benefits with a 36 per cent discount would have a drastic cost on his total lifetime benefit from CPP. The amount he will give up each month compared to the full age 65 benefit, about $5,000 per year, will have cost him $171,500 with no compounding for the following 35 years. It is a very high price to pay for what amounts to a five year bridge to full benefits at 65.

Partial retirement in Michel’s fifties would work as long as he can generate perhaps $20,000 a year to supplement withdrawals from various accounts. Raising savings rates is unlikely for Michel is already very frugal. But retirement at 45 is not feasible with our income, savings and investment assumptions, the planner explains.

Retirement stars: 2 ** out of 5

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