EMPLOYER MIGHT GO BUST, BUT RETIREMENT WON’T NECESSARILY
At the age of 56, Cliff, as we’ll call him, is in a tough spot. His employer recently announced it would be forced to liquidate its business. In spite of decades of experience in his field of inventory management, Cliff worries he won’t get another job. He fears that he may go from earning $ 89,000 a year, as he has done, to having to survive with employment insurance benefits of $545 a week for just under a year or about $ 2,200 a month and then having to use up his savings. There is no company pension plan.
The good side of Cliff ’s dilemma is that he has no dependents to support. He lives modestly. He spends his leisure time volunteering for a charity to which he also gives $ 10,000 a year. In the best outcome, he would get a job for four more years and retire according to his previous plan at age 60.
PRESENT FINANCIAL SECURITY
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Cliff. In his view, Cliff is the perfect survivor. “He is the poster child for financial responsibility,” Moran says. His one “luxury” is the charity he supports. “However, with his frugal ways, his financial assets will cushion the blow of job loss. But we need to map out a survival plan if he remains unemployed.”
Cliff ’s financial situation is clear and highly defensive. His net worth is $ 1,495,290. He has zero debts and all assets other than his $ 600,000 fully paid house and his $ 10,000 fully paid car generate income. As to whether Cliff should sell the house, we can’t speculate on prices in the overheated part of the market where Cliff lives. However, the capital less five per cent for preparation and selling costs, net $ 570,000, could generate $ 17,100 a year invested to generate three per cent annually after inflation but before income tax.
Money f r om t he s al e would support an apartment with a $ 1,425 monthly rent. Cliff could spend a little more, for he would not have to pay property taxes, shovel snow, fix broken pipes or cover other costs of ownership. On balance, sale would probably accomplish little.
CUTTING EXPENSES, RAISING SAVINGS
During his period of unemployment, Cliff can expect up to 46 weeks of employment insurance benefits at $2,090 per month. After that, he will have to draw down some investments.
While looking for work, Cliff ’s present $5,440 monthly allocations will decline. He can skip $ 840 of RRSP contributions, $458 of TFSA contributions and $ 1,540 of other savings. That would cut his budget down to $ 2,600, within a few hundred dollars of the EI benefit. And there is more cash in the pipeline: A $ 15,000 GIC maturing in a few weeks will provide money for roof repairs estimated to cost $5,000, $5,000 for savings and leave $5,000 for investment.
With little trouble, Cliff can raise the income he is currently getting from his approximately $ 283,300 portfolio of non- registered mutual funds. He can shift from his present blend of Canadian stocks to a dividend growth portfolio of large caps, Moran suggests. A dividend yield of 3 per cent would be $8,500 per year or about $ 710 per month. The dividend tax credit would completely offset federal tax in his taxable portfolio. Because provincial tax is a percentage of federal tax, there would be no tax payable. Income tax won’t be a burden until Cliff starts to make RRSP withdrawals from a Registered Retirement Income Fund and goes over about $45,000 in pre-tax income, Moran estimates.
RETIREMENT FINANCES
In a survival scenario beginning at age 56 with no further employment, Cliff can tap into his combination of $458,645 RRSP and $22,768 LIRA, total $ 481,413. He could add income from his non- registered investments of $ 283,300 plus $ 37,700 cash and $15,000 in maturing GICs less $5,000 for the new roof and $ 5,000 retained in cash for emergencies. That’s a total of about $ 326,000. If the sum of registered and non-registered funds, a total of about $807,400, is invested on an annuity basis to pay out all income and proceeds in the 39 years to his age 95, it would generate $ 35,400 a year or about $2,950 a month in 2017 dollars assuming a 3 per cent return after inflation. Use of the dividend tax credit on taxable payouts would reduce tax. RRSP payouts would be taxable as income. He would have to minimize interest-bearing assets, payments from which are taxed as straight income, to make the credit work. However, his income would cover all present spending with zero savings.
At 60, Cliff could get Canada Pension Plan benefits reduced by 36 per cent of his age 65 benefit. His contributions entitle him to about 90 per cent of the $ 13,370 maximum or $ 12,033 at 65. The early start reduction in benefits would leave him with $ 7,700 a year. Taking CPP early is not wise, Moran notes, for it will be his largest indexed source of income. Unless he is very ill, it’s a bad bet and not worth it, Moran says.
If he avoids the early dip, then at 65 he could start CPP at $12,033 and full OAS at $ 6,942 a year, a total of $ 18,975. He could add that to his total investment funds income, $35,400, for pre-tax income of $54,375 a year before tax or $44,375 after 18 per cent average tax. That’s about $ 3,700 a month, far more than the $ 2,591 a month he would need with all savings suspended. Cliff ’s income in his 70s could be higher if he postpones payouts of his $481,413 RRSPS and LIRA. If those funds grow with no further contributions to age 72, they would be $772,500. Annuitized to pay out all income and capital in the next 23 years to his age 95, they would generate almost $ 47,000 a year. His $67,856 TFSA, growing with its investments, would be held in reserve for unforeseen expenses.
NOTE TO READERS
A column two weeks ago addressed a situation in which a dual U. S./ Canadian citizen was considering selling property. Because capital gains can have U.S. tax implications, it is prudent to check with an international tax expert in such a situation.