Do I need to retire my debt, before I retire myself?

Q: So, I’m retiring (single male 65) with $850,000 total in RRSPs and a DCP where I currently work.

I have no debt. I owe $50,000 on a $500,000 home. I pay $730/month. Mortgage is due May 2019. Penalty would be minimal. Should I pay it out in 2018, my first year ‘unemployed’? What are my options?

—Art

A: Retiring debt-free should be a goal for Canadians in their 50s and 60s, but it’s not always possible. And it’s not always bad to retire with debt either. I think yours is a good case study, Art, to illustrate this concept.

With a mortgage that is only 10% of your home value and a net worth of $1.3 million, a $50,000 mortgage doesn’t seem like much, but I understand your dilemma. You’d like to get rid of it and you have this money sitting in your RRSP and your employer defined contribution (DC) pension plan that you could use.

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The problem is, to pay off $50,000 of mortgage debt, you would likely need to take a withdrawal of $65,000 from your investments to be left with $50,000 pre-tax. The exact amount would depend on your tax deductions and credits and your province of residence. But this $65,000 estimate assumes you have no other income for the year. One way or the other, you’re going to either have or need more income, Art.

You may have other income, for example, if you have applied for your Canada Pension Plan (CPP) retirement pension or your Old Age Security (OAS) pension. More on these pensions shortly. If you haven’t applied, you’re going to need more income, simply to cover your living expenses.

Let’s say your living expenses are $50,000 per year and you want to pay off $50,000 of mortgage debt in 2018. Let’s also assume that all comes from your registered investment accounts. In order to have $100,000 after-tax, you would need to take withdrawals of roughly $150,000 depending on your tax deductions and credits and province of residence.

That $150,000 of income may be higher than your income during your working years. Part of the appeal of RRSPs and DC pensions is to make contributions during high income years and take withdrawals during low income years – not the other way around!

On that basis, Art, a more appealing option may be to slowly chip away at your mortgage debt and pay it off over the next five years, for example. That way, you might only need $80,000 of income before tax to cover $50,000 of living expenses and $10,000 of mortgage payments.

You may even get lucky and be able to renew your mortgage in 2019 at a decent rate, though interest rate pressure seems to be building going into 2018.

Of note is that you don’t need to start your CPP and OAS pensions just because you’re retiring or just because you’ve turned 65, Art. If you haven’t already applied for these pensions, you might consider delaying. You can hold off on your CPP and OAS start dates until age 70 and your pensions will be increased between now and then accordingly. Delaying CPP results in a 0.7% monthly increase (8.4% per year) in your pension entitlement. Delaying OAS results in a 0.6% monthly increase (7.2% per year). These pensions are also indexed annually to inflation, so you can expect another 1.5-2% annual increase depending on CPI inflation over the next five years.

Most retirees are reluctant to delay the start of their CPP or OAS pensions. Many figure they’re entitled to these pensions because they’ve paid so much in tax over their lives, so they want to get their hands on the money as soon as possible. Others are reluctant to draw down on their investments, seeing their account balances as somehow more important to protect than increasing their pension income. Yet others are worried the government will somehow take away their pension income, so the sooner they start their pensions, the more likely they are to avoid having their pensions plundered.

I’ll suggest there’s little merit to these concerns in my opinion, but I can totally understand why people would worry. With a full understanding of the benefit of delaying CPP and OAS, I think more people would consider doing so.

Particularly if you think you’ll have an average or longer than average life expectancy, Art, or if you have a low investment risk tolerance, you may want to delay your CPP and OAS pensions. The higher increase in delaying your CPP (8.4% per year versus 7.2% for OAS) may make that a more appealing pension to delay in your case if you’re on the fence and want to start earning some pension income.

A prime benefit of deferring your pensions is you increase your inflation-protected pension income that should last as long as you do. If you live to 110, your pensions will be there for you. Your RRSP and DC pension may not.

In summary, Art, I wouldn’t fuss too much about your mortgage. Pay it down strategically in the coming years. Consider deferring your CPP and OAS pensions if you expect a long life expectancy or if you have a low investment risk tolerance. And try to avoid OAS clawback, a special tax on your OAS pension if your net income on your tax return exceeds about $75,910 for 2018.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

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About Jason Heath, CFP

Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.