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This couple face 'significant risks' if they carry debt into retirement

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DARRYL DYCK/THE GLOBE AND MAIL

"Can I retire at age 65?" Arlo asks in an e-mail, echoing a question posed by so many people in their fifties. Arlo is 57, his wife, Alice, is 53. They are both self-employed professionals, bringing in a combined $265,000 a year before tax. They have RRSP savings but no work pension plans.

Their main asset by far is their $3.6-million Vancouver-area house. "I will work to age 70 if I have to," Arlo writes. "I want to know if we have to sell our home and downsize, which would be okay."

They have also been saving to help their three boys, ages 11, 13 and 18, with postsecondary education.

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When they retire, Alice and Arlo plan to spend $120,000 a year – less than they are spending now. But if they hang up their hats when Arlo is 65, they will still have a mortgage to carry.

We asked Ngoc Day, a financial planner at Macdonald Shymko & Co. Ltd. in Vancouver, to look at the couple's situation. Ms. Day holds the certified financial planner (CFP) and registered financial planner (RFP) designations, among others. Macdonald Shymko is a fee-only financial planning and portfolio management firm.

What the expert says

"While this family has accumulated significant net worth, a large proportion of their wealth is tied up in their home," Ms. Day notes. "They also have a fair level of debt, including a mortgage." For them to retire with $120,000 a year when Arlo is 65 "will be a challenge."

Carrying debt into retirement poses "some significant risks," Ms. Day says, interest-rate risks among them. When interest rates rise, Alice and Arlo will have to renew their mortgage at a higher rate of interest.

When they retire, they will have to withdraw money from their registered retirement savings plans to fund their daily expenses, including the mortgage, while paying income tax at their full marginal tax rate. Assuming a 30-per-cent marginal tax bracket, they would have to withdraw about $4,280 every month to finance the monthly mortgage payment of $2,994, Ms. Day says. "Their RRSP could be depleted."

Indeed, with an estimated 5-per-cent rate of return on their RRSP investments, they could potentially run out of funds by the time Arlo reaches the age of 80, the planner says.

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They have the usual three choices: cut their spending, work longer or sell their house at some point and buy a less-expensive place.

Cut spending: "Given that they are planning already on spending $1,300 less a month in retirement than they are now – which may be achievable with the kids no longer living at home – further belt-tightening may be difficult to achieve and impractical," Ms. Day says. They are spending $136,500 a year, excluding the $1,000 payment to their line of credit, which the planner assumes will be paid off in a few years.

Work longer: If they were to continue working until Arlo reaches the age of 70 and Alice is 66, their spending goal of $120,000 a year "may be sustainable past Arlo's life expectancy and until Alice reaches age 91," the planner says. Her financial plan assumes Arlo lives to 93 and Alice to 96. As they get older, it could be practical to sell their house and buy a condo or move to an assisted-living arrangement.

Downsize: The third option is for them to sell their house and buy something less expensive. They would not have to do so immediately, Ms. Day says. If they could buy a place for $1.8-million in today's dollars, they could defer downsizing until Arlo is 78 or 79. "This allows them to stay in their current home past age 65 and to accommodate their children if one or more still needed to live at home short term."

A caveat is whether house prices continue to rise in line with inflation, which Ms. Day assumes to be 2 per cent a year. If the price of large, expensive houses were to lag relative to the price of smaller units, such as condos, "they may not be able to release as much capital" from downsizing as they had hoped.

To err on the side of prudence, they couple may choose a combination of working a few years longer and downsizing when their family situation permits, the planner says.

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"As their desired retirement-income level is significantly less than current expenses, they would be wise to begin monitoring expenses in the next few years and begin to trim down on discretionary spending now," Ms. Day says. "Reducing expenses gradually in the years before retirement would help them get used to living at the same level before and after retirement, rather than having to cope with the shock of a big drop of spending in retirement."

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The people: Arlo, 57, Alice, 53, and their three children.

The problem: Can they afford to retire when Arlo is 65 with $120,000 a year?

The plan: Spend less, work longer, downsize their house or some combination of the three.

The payoff: A good chance of achieving all of their financial goals.

Monthly net income: (includes dividends from Arlo's corporation) $15,762

Assets: Cash in bank $22,000; residence $3.6-million; TFSA's $5,600; his registered retirement savings plan $785,983; her RRSP $677,749; RESP $156,574. Total: $5.2-million

Monthly disbursements: Mortgage $2,994; property tax $650; utilities $460; home insurance $200; maintenance, garden $100; transportation $1,240; groceries $1,200; clothing $225; line of credit $1,000; gifts, charitable $40; vacation, travel $800; dining out $1,200; drinks, entertainment $200; grooming $50; club memberships $325; sports, hobbies $275; pets $25; subscriptions $25; doctors, dentists $100; drugstore $100; health, dental insurance $125; life $150; disability $250; cellphones $400; phone, TV, Internet $236; RRSPs $2,000; RESP $400; TFSAs $800. Total: $15,570. Surplus: $192

Liabilities: Mortgage $660,446; line of credit (for renovation) $60,754; B.C. property tax deferral $30,000. Total: $751,200

Want a free financial facelift? E-mail finfacelift@gmail.com

Some details may be changed to protect the privacy of the persons profiled.

Video: Money Monitor: What to be wary of when borrowing in retirement (The Canadian Press)
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