Couple needs to go into financial survival mode
In Ontario, a couple we’ll call Larry, 55, and Margie, 48, are caught in a vise of misfortune. They are both unemployed, Larry by choice in voluntary retirement and Margie by an unexpected layoff. They live in a one-bedroom condo. They have no children. Margie’s termination payments maintain their comfortable way of life, but they will end in October.
The challenge is to go from a life of good restaurants and entertainment — budgeted at $1,000 a month — to a slender budget structured for what could be a five- to 12-year wait until pensions and CPP benefits start.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Larry and Margie. Before Larry can take early Canada Pension Plan benefits in five years or Margie starts her company pension in 12 years, they will have to live on her employment insurance payments of at most $547 per week for as much as 36 weeks and $780,000 of financial assets, mostly held in RRSPs and TFSAs. A drawdown of savings will encroach on retirement spending, Moran notes.
SURVIVAL BUDGETING
The couple must survive until Larry’s reduced Canada Pension Plan benefits become available in five years and Margie can take her pension and reduced CPP a dozen years from now. Supporting present monthly allocations of $10,085, even with $4,000 allocations to savings eliminated, is the challenge.
They must find a way to generate $6,085 per month after tax from present $780,000 assets. That works out to $73,020 per year assuming income is split and then taxed at an average 10 per cent rate. That would require $81,133 pre-tax annual income. At three per cent a year after inflation and no consumption of capital, they can get $23,400 per year or about $1,950 per month Thus they will have to work, perhaps part time, in order not to impair retirement spending after age 60 or 65. This is the critical baseline.
In survival mode, they should do budget surgery to cut their travel, entertainment and miscellaneous spending, which each now cost them $1,000 month. Those cuts could reduce spending to as little as $3,085 per month, but that still checks in above their current projected income.
They can access $70,000 in Margie’s TFSA account, but that alone cannot support them for more than a year or two.
Margie has a $200,000 line of credit used for taxable investments. Interest paid is tax deductible. She can clear the loan by selling assets. Keeping up with rising rates will take riskier investments. Eventually the loan and taxes due on any gains must be paid.
RETIREMENT INCOME
If we assume that retirement starts now, their unimpaired $780,000 of registered and non-registered assets invested for a longterm return of three per cent after inflation for the 42 years to her age 90 would generate $32,900 per year or $28,000 per year after 15 per cent average tax. That’s $2,330 per month, far from even present spending without frills. That is their potential income base if there is no other money coming in and it is more than they will have if they spend Margie’s TFSA savings.
At age 65, given Larry’s present retirement and Margie’s uncertain job future, we’ll assume that each gets 70 per cent of Canada Pension Plan benefits in 2018 dollars based on the present annual maximum of $13,610. That would give each $9,527 at 65 or $6,097 with a 36 per cent discount at 60. Old Age Security will start when each is 65 at a 2018 rate of $7,160
per year in today’s dollars.
A dozen years from now at 60, Margie can access a job pension that will pay her $27,600 per year plus an annual bridge of $8,400 to age 65. At 65, she would lose the bridge. Larry would be 67 and drawing $9,527 CPP or less if he starts before 65, and $7,160 Old Age Security at present rates. Their current financial assets set to start payouts in 12 years when she is 60 and Larry is 67 with no further contributions could generate annuitized payouts for the following 30 years of $38,800 per year.
At Margie’s age 65 the couple could have Margie’s $27,600 job pension, two CPP benefits of as much as $9,527 each, two OAS benefits of $7,160, and $38,800 payouts from present financial assets assuming the $780,000 does not grow after tax and inflation and is paid for 30 years to her age 95 exhaust capital. The pretax total is $99,774 per year. With splits of eligible pension income and various tax credits, they could pay tax at a rate of 14 per cent and have $7,150 per month to spend. That would cover current expenses with restaurants and travel restored but without any savings and allow some extra funds for travel.
ASSET MOVES
Larry has no TFSA, so a move of some money from Margie’s taxable investments could be considered. Tax on gains would have to be evaluated. A relative who has promised a $100,000 bequest at death may pass away, but we do not wish to time this unfortunate event. That bequest, at a three per cent annual return but no annuitization, would add $3,000 a year to income, a vital sum before the couple can draw on CPP and Margie’s company pension but less essential when other income sources are flowing.
A final consideration is that Margie could take the commuted value (the sum required to pay out benefits) of her job pension. That would be about $700,000. If considered a perpetuity (a sum paid forever), it would generate $21,000 per year at three per cent. That capital could be annuitized to pay out all capital and interest at $29,400 per year for four decades assuming a three per cent return after inflation. Margie would gain a few thousand dollars per year but lose a rock solid guarantee of professional management and cash flow as long for as she is alive. The present pension has a 100 per cent survivor option to cover Larry if Margie predeceases him. It is too dependable and valuable to liquidate, Moran says.