Kayla from PEI emailed me for some advice about her financial situation. She is 50 with a mortgage and small RRSP. She’s wondering where she should focus her money as she hopes to retire when she is 55. Here is more information about Kayla.
- RRSP Portfolio Value: $6,000
- RRSP Contribution: $110/month
- Gross Income: $67,000 (after tax ~$3,220/month) increasing 2.25% per year
- Mortgage Payment: $504 bi-weekly ($50 to property tax) @ 5.4%
- Mortgage Balance: $84,000, 10 years remaining.
- Car Loan: $14,000 @ 5.25% (~$265/month for 5 years)
- Pension can start at age 55 with annual pension income of approximately: $42,000 per year (after tax ~$2600 /month)
- Monthly Expenses (not including debt servicing): $1,400
- Total Expenses: $2,757/month (without RRSP contribution)
With retirement on it’s way, Kayla will have to make a few changes. I’m of the belief that all debt should be eliminated by the time that retirement starts. For many, retirement income is fixed, who wants a portion of that income still servicing debt?
Another point I’d like to make is regards to RRSP contributions in addition to pension contributions. In my opinion, if someone is fortunate enough to have a lucrative defined benefit pension plan, then debt servicing should come before any RRSP contributions. Once debt is eliminated, I would personally move to maxing out the TFSA, then to the RRSP. I would go that route because RRSP withdrawals are taxed as income which would be on top of any pension income received during retirement.
Having said that, looking at the financial specs above it seems apparent to me that she should focus on paying down her mortgage. Even without looking at anything else, paying off the mortgage represents a 5.4% guaranteed after tax return which would be challenging to find anywhere else. Once Kayla eliminates her mortgage, she will free up about $1,000 /month in cash flow (she’ll still have to pay property tax). Should Kayla take her $110/month RRSP contribution and put it directly on her mortgage payment, her mortgage amortization would reduce to 8 years. If she really want to retire in 5 years mortgage free, she would need add $300 to her bi-weekly payment.
If Kayla turned 55 today, her car payment would be gone but a mortgage payment would remain. Her total monthly expenses would be about $2,500 with a monthly income of approximately $2600. Too close for comfort especially if inflation is added to the expenses over 5 years. However, when the mortgage is paid off, the monthly expenses would reduce to $1,500/month leaving a healthy cash cushion. To add to the picture, when Kayla turns 65 and assuming she qualifies, she’ll be eligible for Old Age Security which would give her another$516 /month (in today’s dollars).
In conclusion, it may be in Kayla’s best financial interest to pay off all debts before calling it quits. It will give her a more comfortable retirement and perhaps peace of mind. If Kayla were to simply redirect her RRSP contribution to her mortgage, then she could join the retired club in as little as 8 years. Not exactly freedom 55, but freedom 58 has a nice ring to it too.
Back to you, how would you advise Kayla about her financial situation?
Disclaimer: I’m not a financial advisor, anything written in this post should be used for informational purposes only.