Retirement done right
In Alberta, a couple we’ll call Frank, who is 57, and Ella, who is 51, emigrated to Canada decades ago to find work and build secure lives.
Starting with nothing but their will to work, Frank in a municipal civil service job, Ella in health care, they have built up about $705,000 of net worth, most of it in their $490,000 home. They worry, however, that their income from about $184,000 of financial assets plus two civil service pensions at 65 plus CPP and OAS may not be enough to sustain their retirement. The irony is that their Canadian assets would make them very wealthy in their countries of birth. In Canada, though, they worry that their liabilities could sink their retirement.
It is a legitimate concern, for they have a $70,000 line of credit to pay off at $1,200 a month, about 18% of their $6,500 combined monthly take-home pay. The line of credit was taken out to buy into a speculative land development in which they are co-owners of undivided land rather than sole owners of a defined parcel. It is a risky investment that produces no current income. Moreover, they have $37,500 in a mortgage fund in their RRSPs that yields 10% a year. That yield implies the mortgages carry more risk than banks and credit unions accept.
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Frank and Ella, who still have a daughter at home attending university.
“The good thing about the couple’s financial affairs is their dedication to their work and their home,” he says. “The not-so-good thing,” he notes, “is that they appear to have made investments in land and mutual funds on the basis of trust in advice.”
The interest on the loan to buy the property is not tax deductible, though it can be added to the adjusted cost base of the property, eventually reducing the taxable capital gain. Best bet: Sell the land to pay off the line of credit and capture a capital gain, which the couple believe to be about $30,000 or $20,000 after costs. We’ll assume they just get their money back, then invest in lowfee mutual or exchange-traded funds focused on producing dividends.
RETIREMENT MATH
At retirement at 66, Frank will have a $675-a-month work pension, a full Old Age Security benefit of $6,612 a year and a Canada Pension Plan benefit of $7,290. At that time, Ella will be 60 and could take her CPP benefit with a 36% reduction. That would work out to $4,373 a year or she could wait to 65 and receive $6,833 a year.
Frank and Ella have RRSP and TFSA accounts that total $179,226 plus cash savings. If they continue to add, as they are doing, $1,455 a month, or $17,460 a year, for another eight years to Frank’s age 66 and grow all savings at 3% over the rate of inflation, they would have about $387,000 in 2013 dollars.
These funds, still generating 3% a year, could support an income of $19,170 a year for 30 years from Frank’s retirement to the beginning of Ella’s 90th year.
If they manage to sell their land, clear their debt and then bank the interest they have paid on the line of credit ($1,200 a month), then total monthly savings would rise to $2,655 a month, or $31,860 a year. After eight years, assuming 3% return over the rate of inflation, they would have $518,850 in 2013 dollars. If these funds continue to grow at 3% over the rate of inflation and are spent for the 30 years from Frank’s age 65 to Ella’s age 90, they would generate an income of $25,700 a year.
Chances are that, even if they cannot sell the land immediately, they can sell it at some time before retirement. If they retain the land for lack of a buyer or because they think they will eventually make a very large profit, their retirement income would be $6,535 less. That would be a 10% drop in their potential pre-tax income.
Putting the figures together, at 67, when Ella is receiving her Old Age Security benefits, the couple’s income would consist of two CPP benefits totalling $11,663 a year, two Old Age Security benefits that will total $13,224 a year, 30 years of income (assuming land sale) from their savings of $25,700 a year and defined-benefit pensions of $17,100 from former jobs. Their total income will be $67,687. If they split their pension incomes and pay average tax at a rate of 10% after basic and age credits and the pension income credit, they will have about $5,075 a month to spend. Their disposable income will be more than the approximately $3,850 a month they live on now after all savings and debt service charges are eliminated.
REDUCING INVESTMENT RISK
With diverse sources of retirement income, Frank and Ella should have a secure retirement. Yet they need to protect their defined-benefit pensions. They have received an offer from a financial adviser to swap $58,600 of Frank’s locked-in RRSP funds for investments in equity mutual funds. Frank, ever cautious, has not done it, yet neither has he dismissed the idea.
Defined-benefit pension plans tend to have expert management and low fees charged to members. Mutual funds have diverse performance, but they tend to underperform their benchmarks over extended periods. Frank should follow his sense of caution and leave his pension plan with low-cost professional management, Mr. Moran suggests.
Frank and Ella can get more out of their capital by adjusting their portfolio, which has both equity and bond investments, to raise retirement income and reduce fees. They have established a way of life that can be sustained with their retirement savings and pensions, Mr. Moran says.