New career goal carries some risk

SITUATION Woman with substantial investments wants to quit boring management job, return to university and start a new career STRATEGY Build a financial fortress with diversified assets, use income for years of study and a fresh start

At the age of 46, a woman we’ll call Carol wants to switch careers. She has done well, but she is at a crossroads. Phased out from a previous job managing financial services, she moved down the salary scale to take what was available after an 18-month absence from the labour force. The new job, middle-level marketing management for a local company in Saskatchewan, is far from her former job’s $100,000 salary and generous bonus. Nor does it interest her.

Carol is prepared to take a leap from her present job to a period of four to six years when she would return to university and learn a new career in the pharmaceutical industry. That is a big commitment of time — a concern of its own.

She would need a master’s degree and a PhD. Not only might she not make it through the grind of courses and a doctoral thesis, but she will have to pay the bills out of her savings. She will go from the security of her present job to something unknown with all the challenges of finding new work and starting a career. It is a leap of faith, a bet on her own commitment and ability to start her professional life over from scratch. She could fail, after all. And then there are the costs, both outof-pocket tuition and books, which she can pay with her substantial assets, and the loss of income during years of study.

“That is what worries most of all,” she says. “I can certainly live with my assets and present income, but if I give up my job and study for six years, what will be left?”

Carol earns $48,000 a year now, so the income loss would be almost $300,000. Question is, can her substantial resources — almost $1.7-million — sustain the years of study to come and the possibility that she will have trouble finding a job? After all, when she is done, she will be in her early 50s and competing with other new grads in her field who are in their late 20s.

“I tried retiring 18 months ago, but found myself panicky about money,” Carol says. “I would like to work in health care. Can I afford to quit and take on as much as six years of study?” Her anxiety about the shift back to being a student is understandable.

Family Finance asked Benoit Poliquin, a chartered financial analyst who is lead portfolio manager for Exponent Investment Management Inc. in Ottawa, to work with Carol.

“Some of her issues are motivational and emotional. But I can deal with her ability to finance the transition to a new career and to handle the consequences of the shift, even it does not work out,” he says.

Carol’s biggest problem is that 80% of her financial assets are invested in just one firm. The remainder is in a risky $125,000 promissory note with a 15% theoretical return, and a few leases of farm land with high potential rates of return but exposure to volatile livestock prices. She has made a few large bets, each of which has substantial risks, Mr. Poliquin says. In a market crash driven by rising interest rates or any other shock, she could sustain big losses that might force her back to work, making her studies impossible to continue. Giving up an income stream that could compensate for these losses adds to the risks she is taking in giving up her present job.

Converting her portfolio from its heavy reliance on financial services and lowering risk could be expensive, Mr. Poliquin notes. Her total tax bill for selling appreciated shares she acquired via stock options granted as compensation for work done in her former job would be nearly $350,000. One could argue she is better off to take the risks that go with overconcentration and save the tax, but, Mr. Poliquin notes, the tax will have to be paid eventually.

Her best bet is to cut overconcentration by selling some of her shares over a 12-to-24-month period. Carol could cross two or even three tax years and so average out and postpone some of the costs of sale of stock. The process would reduce portfolio risk and therefore be a buffer for financial losses if her new career does not flourish.

In developing a diversified portfolio better able to withstand market shocks, Carol needs to consider her need for income. Her annual expenses net of RRSP and TFSA savings are about $38,500 a year or about $3,200 a month. These expenses would not change much if she quit her job and went back to school. She would have to pay tuition, but she would live at home. Her expenses might rise to $44,000 a year.

Assuming she sells her shares and diversified assets eventually rise in price enough to recover the taxes she must pay, her taxable portfolio of $1.73-million generating 4% a year would produce $69,200 in taxable income. Add income from the $125,000 promissory note, which has been paying 15% interest, $18,750 a year, and she would have $87,950 before tax or about $5,100 a month after 30% average tax.

That would cover her tuition bills and living costs while at university and still allow her to save $1,900 a month. Some savings could be used for contributions to her TFSA. Her registered assets, $236,150 in RRSPs and $25,042 in her TFSA, total of $261,192, would add about $10,500 a year at 4% annual growth after inflation. There would be no further contributions to her RRSP though she would maximize shifts of taxable funds to her TFSA every year.

Over 19 years to age 65, she would build up $855,000 in her registered plans, assuming compounding twice a year. That income would generate $34,200 before tax. Her non-registered assets, assuming a 4% return, would continue to generate $69,200 a year. Those two income sources would total $103,400 before tax each year. Her Canada Pension Plan income would be $11,250 a year. Her annual income at 65 would total $114,650 and all Old Age Security, which she could receive at 67, would be clawed back. After 35% average tax, she would have $6,200 in 2013 dollars to spend per month, Mr. Poliquin estimates.

Carol’s assets should cover her financial risks, but, as Mr. Poliquin says, “when you give up a job and try to live on savings, which might suffer in a bad market and for what could be decades if the new career does not work out, the risks are clear and inescapable.”