Woman mortgage free at 42 wonders what to do with extra cash

Stephanie put off saving for retirement in favour of making extra mortgage payments, so where to put her money now?

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Stephanie* is 42, single and will be mortgage free this September, which means she will soon need to know how best to allocate her extra cash.

She purchased her Greater Toronto Area home 15 years ago with the singular goal of owning it outright as soon as possible. This means she has foregone saving for retirement in favour of making extra mortgage payments and the guaranteed return of being a debt-free homeowner. The house has since tripled in price and is currently valued at $950,000.

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“I’m a saver by nature,” she said. “My expenses basically match my income and I’m about to have what I feel is a windfall, but I don’t want to treat it like it’s a windfall.”

For the past five years, Stephanie has been on disability leave and has had to manage her finances based on disability benefits of $3,645 a month.

“I’m not sure if I’ll ever be able to return to work,” she said. “The payments are not indexed to inflation and will remain at this amount until I take my pension, at which point the benefit stops.”

Stephanie is eligible for a defined-benefit employer pension of $21,000 a year indexed to inflation in 2046 when she turns 65.

She lives frugally, invests $400 a month in a tax-free savings account (TFSA), which contains guaranteed investment certificates and exchange-traded funds, and is currently worth $23,000. She also contributes $125 a month to a registered disability savings plan (RDSP) valued at $83,500. Her largest expense is her monthly mortgage payment of $1,198.

“Once the mortgage is paid, should I increase my TFSA contributions to $1,000 a month? I’m already contributing the maximum to my RDSP to get the government grant of $3,500. Or could I invest $750 a month in my TFSA and use the remaining $250 for everyday living?” she wonders. “My car is 12 years old and I know I’m going to have to replace it, but I want to keep it running as long as I can. I’ve modified it to make it more accessible, which I will have to do again to a newer vehicle.”

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Stephanie’s overall aim is to have saved $500,000 in her TFSA and RDSP by age 60, when mandatory RDSP withdrawals start. But how does she get there? Is upping her contributions to $750 a month enough?

“I’ve been basing my investments on assuming returns of between four per cent and five per cent” she said. With higher interest rates and inflation, she wonders if her $500,000 goal will be enough for a comfortable retirement. “I’ll have my pension, Canada Pension Plan and Old Age Security, and I have the house.”

Ideally, Stephanie would like to stay in her home as long as possible. She has renovated to make it more accessible, and she’s near friends and family.

“Eventually, I may sell or borrow against it,” she said. “Until then, how can I build up my savings to be able to draw on them when the house and car need repairs while also saving for retirement?

What the expert says

“Stephanie is doing all the right things. She is living within her means, paying off all debts, taking advantage of powerful savings accounts and is focused on planning for her future while she still has time to adjust,” Eliott Einarson, a retirement planner at Ottawa-based Exponent Investment Management, said.

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“Her best next step is to request a review of her investments and savings projections from her RDSP and TFSA providers. This will give her clarity about the future and help her decide what to do with the extra cash flow once her mortgage is paid off.”

Einarson said rather than focusing on achieving a target savings amount — in this case, $500,000 by age 65 — Stephanie should focus on future needs and allocate her money accordingly, particularly since her expected pension and government benefits are secure and will meet her living expenses in retirement.

“Stephanie’s current monthly living expenses, not including mortgage payments and contributions to her savings accounts, total $1,920,” he said. “An absolute minimum target of $2,000 in today’s dollars to meet her most basic needs can be her starting point for retirement. Income beyond that will only improve her standard of living and ensure she can afford to stay in her home as long as possible.”

At 65, Stephanie will have three reliable sources of income each month to meet her needs: a defined-benefit pension ($1,750), CPP ($1,122) and OAS ($713) for a total of $3,144 after tax in monthly income to meet her basic retirement needs and fund any additional lifestyle choices or expenses related to staying in her current home.

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Einarson said her RDSP is a great account that can help supplement her other guaranteed sources of retirement income, starting at the age of 60, when she will have to start withdrawals.

“Many Canadians with a disability do not take advantage of the RDSP, which can help accelerate savings with multiple times matching government benefits,” he said.

The TFSA can also be a powerful savings tool to help her manage the impact of inflation and fund large expenses. Once her mortgage is paid off, Einarson recommends Stephanie allocate $900 of the freed-up cash flow to her TFSA. This will boost her contributions to $1,300 a month and still leave her with $300 a month in additional funds to put towards everyday living.

“She can use multiple TFSAs, or she can use one TFSA with three different asset allocations to allow her to establish short-term/emergency funds, medium-term savings for a new vehicle and longer-term tax-free investments for her retirement,” he said.

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“If she contributes $1,300 a month to her TFSA until age 65, she would have $650,000 based on a modest rate of return of four per cent. Even if she needs to buy a car or make home repairs before age 65, she will still likely get close to her $500,000 goal in her TFSA.”

Beyond the TFSA, Stephanie can expect her home equity to continue to rise, adding another layer of security for her future.

* Name has been changed to protect privacy.

Are you worried about having enough for retirement? Do you need to adjust your portfolio? Are you wondering how to make ends meet? Drop us a line at aholloway@postmedia.com with your contact info and the general gist of your problem and we’ll try to find some experts to help you out while writing a Family Finance story about it (we’ll keep your name out of it, of course).

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