A FRUGAL LIFE, BUT AN EVEN MORE FRUGAL RETIREMENT AHEAD
Life in Alberta for a couple we’ll call Sally, 52, and her husband, Victor, 62, is a cocktail of part- time work by choice and round- theworld travel. They have volunteered at bird sanctuaries in far off lands, climbed the Andes, and worked interesting jobs — his in guiding tours around Alberta’s glaciers, hers in the business of arranging trade shows. Together, they bring home $ 7,095 a month based on two salaries that add up to $ 6,378 after tax and Victor’s monthly Canada Pension Plan benefit of $ 717. They have no children, buy clothes at consignment stores, and keep their grocery budget down with the free lunches their employers provide. Their plan — retirement in five years.
The problem they face is whether they can afford to quit work. Will the sum of their financial assets, about $ 443,000 and a $ 550,000 home they might sell, less their liability — a $ 165,000 mortgage — plus CPP and Old Age Security, sustain them for decades of good health?
On the plus side is their zeal to do things on their budget by keeping expenses in check and maintaining their savings.
“We may sell our house in five years, then rent a home,” Victor explains. We have no company pensions, so we are willing to do part-time work until we die.”
THE CHALLENGE OF RETIREMENT
Family Finance asked Eliott Einarson, a financial planner with Diamond Retirement Planning Ltd. in Winnipeg, to analyze the viability of the couple’s plans. “They are frugal in a general sense, but they travel a good deal and have a couple of classic sports cars that are going to be sold. They expect to travel less, work less, and spend less. The plan is going to succeed or fail on the amount of income they can generate from investments and their CPP and OAS benefits.”
Sally and Victor are already migrating toward retirement. Sally works four days a week, Victor works about half time — just 14 days a month. They have been making RRSP contributions of $1,250 and $400 a month, respectively, and putting $5,500 per year each — the annual maximum — into their Tax-Free Savings Accounts. At present, their largest discretionary expense is travel, $750 a month, which they plan to reduce in retirement.
A mortgage with $165,000 outstanding carries a 2.09 per cent interest rate. Even adjusted for tax — they pay in after- tax dollars — it’s almost f r ee after i nflation. They could use their $ 172,000 taxable i nvestments to pay it off, but there would be some capital gains tax to pay on the investments. They can get a better return by leaving the mortgage and investing wisely, Einarson suggests.
Sally and Victor have $ 443,385 in financial assets in RRSPs, TFSAs and taxable savings accounts as well as a home with what they think is a $ 550,000 value in the present market.
Their RRSPs add up to $ 170,000. Just as a savings discipline, they continue to add $ 1,650 per month and if the accounts grow at 3 per cent a year after inflation, they would have $305,000 in five years. That capital could generate $ 14,700 per year if spent over the 33 years to Sally’s age 90.
They have $ 101,385 in their TFSA accounts. If they continue to add $ 11,000 a year for the next five years, then with a 3 per cent return after inflation, they would have a balance of $ 176,000 in five years. That sum, with the same assumptions, could provide $8,500 a year for the next 33 years.
Their savings accounts, which currently total $ 172,000, growing with no contributions at 3 per cent after inflation would total $ 199,400 and support payouts of $ 9,600 per year for 33 years.
Finally, if they sell their home in five years and obtain $ 550,000 less selling costs of 5 per cent or $27,500, they would net $522,500 less the outstanding mortgage — say $ 100,000 remaining. If they annuitized $422,500 for 33 years at 3 per cent after inflation, it would support payouts of $20,345 a year.
ADDING UP INCOME
The sum of investment accounts and income from their house sale would provide $53,145 a year or $4,430 a month. On top of that, they would be able to add Victor’s present Canada Pension Plan benefit of $717 a month, Sally’s expected CPP benefit of $ 947 a month at age 65, and Old Age Security payments at 65 for each of $579 a month per person. The total of investment returns and government benefits would be $ 7,252 a month or $6,240 after tax.
Their expenses, currently $ 7,157 a month, would have changed. They would not make monthly allocations of $1,650 for RRSP contributions. Their $ 1,000 monthly mortgage payment would be history in little more than a dozen years. They would save perhaps $200 a month on reduced insurance payments for fewer cars — maybe just one. They might have to pay rent of $ 2,000 a month for replacement housing after sale of their home, while food spending might rise about $ 200 a month without free work lunches. Revised expenses of $ 6,507 a month would not be fully covered by expected income. Part- time work would be essential until rising RRIF distributions cover the deficit in their mid to late 70s. Prolonged illness or other unexpected expenses could throw their financial plans out the window.
RAISING RETURNS
What to do? Their financial assets could be much more productive, Einarson explains. Their RRSPs and TFSAs are invested in mutual funds with companies with conventional fees of about 2.6 per cent for stocks and 1.6 per cent or so for bonds. Each year, based on the present asset values for RRSPs and TFSAs invested in mutual funds, a total of $ 271,000, they pay fees of approximately $ 5,400 for management. If they were to shift their accounts to exchange traded funds with fees of a fifth of a per cent or less, they could have another 2 per cent or so of asset yield. That would provide a margin for unexpected health and other costs.
“They don’t have a large amount of wealth, but what they have will be enough for life adjusted for a little less travel, a few years of part time work, and volunteer work with their charities,” Einarson says. “They have lived frugally to live even more frugally in retirement.”