‘Solid career and solid savings make this work,’ planner concludes
In Alberta, a woman we’ll call Helena, 39, has been working for a large energy company for 16 years. Her employment income, $9,000 per month after tax, and good investment decisions have allowed her to build up about $1.3 million net worth. Her only liability is a $204,000 mortgage on a rental condo. Her issue — after 16 years pushing a pencil, she wants out.
“Can I retire between 40 and 45 with $40,000 per year after tax from investment returns?” she asks. The assumption is that she could support her way of life with what are currently very Spartan expenses if mortgage payments for the rental condo, $4,000 per month, and various savings of $1,750 per month and hefty home maintenance costs of $895 per month are taken out. That would reduce her cost of living to $2,355 per month.
Family Finance asked Eliott Einarson, a Winnipeg-based financial planner with Exponent Investment Management, a national portfolio management firm with headquarters in Ottawa, to work with Helena.
“This is a case of a woman who has been putting in 60 to 100 hours a week for the last 16 years and now wants a drastic turnaround in her life, retiring as soon as possible,” Einarson explains. “Her plan is based on health issues, a family history of mortality before normal retirement age, and swapping her very technical job for travel, friends and yoga. In our analysis, we work with her early retirement goal but assume normal life expectancy.”
RETIREMENT AT 40
Making retirement work at the very early age of 40 one year from now would be a challenge.
Her rental condo income is negative: she is paying $4,000 per month and receiving monthly gross rent before expenses of $1,675. Her goal is rapid paydown to rid herself of her only significant debt. Some of the return is accretion to her own equity. But the unit is cash-flow negative.
She currently has $306,000 in her RRSP, and contributes $1,250 per month with an additional $250 monthly top up by her employer. Assuming the assets grow at three per cent after inflation, her RRSP should reach $333,180 after one year, enough to generate taxable income of $12,600 a year to her age 90.
A registered pension plan with her employer, meanwhile, has a commuted value of $168,000 and receives contributions of $1,440 per year. Her work pension would have grown to $174,500 with the same assumptions and could provide another $6,600 per year of income.
Her non-registered investments, $160,000 growing at $14,400 per year out of her own cash flow would have a value of $179,200.
If she were to draw on her non-registered investments of $160,000 to fill current TFSA space of $57,500 with the balance going to nonregistered investments, then in a year her TFSA would have a value of $64,890 and the $102,500 remaining in the non-registered account could grow in a year to $105,600.
At 40, the TFSA could generate $2,520 of income and the non-registered account would generate $4,000 a year of income to her age 90. So far, that’s a total of $25,720 per year.
ALTERNATE PLAN
If Helena were to sell the rental condo for, say, $440,000 after selling costs, she could pay off the mortgage which in a little over a year will have declined to $156,000 outstanding. She would clear $284,000 cash profit. Assume that capital gains tax costs her $35,000. The balance of money from the sale, if annuitized at three per cent for 50 years, could generate $9,395 per year.
Helena’s annual income at this point would be $35,115 before tax, say $31,000 a year or $2,550 per month after 15 per cent average tax and zero tax on TFSA payouts. That’s just enough to cover her reduced living costs of $2,355 per month with no savings or debt service expense. Helena will need to stay on the job a few more years to have more money and enough savings to cover such major outlays as a new car or repairs to her home.
WAITING TO AGE 45
If Helena retires in six years at her age 45, she could meet her income targets. At this point, her RRSP with the present contribution rate would be worth $485,300 and could provide $19,500 per year to her age 90, assuming a three per cent rate of return after inflation. Her company pension could be worth $210,000 and could support payouts of $8,660 per year with the same assumptions. Her TFSA with $5,500 annual contributions would have grown to $105,300 and would support payouts of $4,300 per year. Finally, her nonregistered investments would have grown to $181,700 and could add $7,400 to her annual income. Finally, her condo’s value if realized and invested at three per cent for 44 years, would add $9,967 per year. All that adds up to $49,827 before tax per year.
After 16 per cent average tax on all income but the TFSA payout and arithmetic to add TFSA payouts back in, she would have monthly income of $3,550. That’s $42,543 a year or $3,545 per month — a little over her after-tax goal. At 65, she would be able to add Old Age Security payments at present rates of $597 per month and Canada Pension Plan payments attenuated by cutting 20 years out of her career of $9,996 per year.
Helena’s total income from age 65 to age 90 would be about $67,000 per year. Adjusted to remove tax from TFSA payouts and to apply pension income credits from age 65 onward, she would pay an average rate of 15 per cent on all but TFSA income. She would have about $4,800 per month to spend to her age 90, enough for core expenses and some luxuries. After 90, with her financial assets exhausted, she would have her present condo residence, OAS and CPP benefits plus returns from money she has not expended. “Solid career and solid savings make this work,” Einarson concludes.