Can this Ontario couple with a net worth of $2.4M afford to retire in the sun?
In Ontario, a couple we’ll call Trish, 58, and Ellis, 60, have built a comfortable life. Trish has retired from a local government unit. Ellis, a public safety manager, plans to retire within two years. Each has a defined-benefit pension. They have an enviable net worth of $2.4 million, including an $850,000 house that is fully paid for. They save $1,250 per month. They have purchased a new recreational vehicle that sits in their driveway, waiting to take them on an odyssey around North America. Their net monthly income after tax, $7,825, exceeds their spending of $6,575 per month, not counting savings. In full retirement, they want $7,500 per month for spending and a second home somewhere warm.
Trish and Ellis are financially secure, yet they are concerned about whether they will be able to maintain their way of life if they winter in the south and keep two homes. They have not bought or rented American property before, and would be wise to do some research on the costs so they understand the limits of their budget. They would like to buy a boat for use in the south — at a potential cost of $130,000 — and use their motorhome for travelling half the year in Canada.
“Can we aff o r d a two-country lifestyle?” Trish asks.
Family Finance asked Owen Winkelmolen, head of Planeasy.ca, a London, Ont., advice-only financial planning service, to work with Trish and Ellis.
INVESTING
Winkelmolen notes that the couple’s investing style, which mostly involves segregated funds that guarantee the return of at least 75 per cent of invested principle, is diligent, but perhaps overly cautious. segregated funds tend to have higher management fees than mutual funds that come without such guarantees.
The guarantees, however, seldom come into play, for there are very few tenyear periods during which the end value of diversified market indices is less than the start value. The peace of mind that comes with being protected in the event of even a worst case end point, such as the fall of 2008 or March 2020, comes at a high cost. Trish and Ellis pay expense ratios as high 3.24 per cent for their U.S. equity fund.
One can argue that Trish and Ellis are overpaying for security. Their allocation is 30 per cent stocks, 10 per cent bonds and 60 per cent guaranteed investment certificates and cash.
“Their 30/ 70 ratios of stocks to fixed income is far from the 60/40 asset allocation appropriate to their situation.
With two defined- benefit plans, CPP and OAS as a foundation for their retirement income, they can afford to take more market risk in equities than they presently carry,” Winkelmolen explains.
In two years, when Trish is 60 and Ellis is 62, they can begin drawing on their investments.
Their registered assets, which should hold $360,225 at retirement, will be growing at an estimated rate of just one per cent over inflation due to their high investment fees.
That would give them $12,250 per year for 35 years starting in 2022 to Trish’s age 95, Winkelmolen estimates.
The couple’s TFSAS, with a present value of $172,000 and growing with contributions of $12,000 per year for the next two years would increase to $195,426 with the same assumptions to a value of $199,820 and then generate a non-taxable return of $6,725 per year to Trish’s age 95.
On top of their investment income, Trish will have a defined-benefit pension of $39,480 per year and Ellis a DB pension of $57,876 per year.
RETIREMENT INCOME
PROJECTIONS
In the first two years of retirement they will have total income of $12,250 from RRSPS, $6,725 from TFSAS, and $97,356 from pensions. That adds up to $116,330 per year. With splits of taxable income and no tax on TFSA cash flow and a 16 per cent rate on the rest, they would have $8,235 per month to spend. That’s more than their after- tax goal of $ 7,600 per month.
After Ellis reaches 65, his pension loses his bridge benefit of $ 9,780. He will gain Old Age Security, currently $7,362 per year, and estimated Canada Pension Plan benefits of $ 14,156 per year. Their pre-tax cash flow would have risen to $128,070. With splits of eligible income and no tax on TFSA cash flow, they would pay tax at an average rate of 18 per cent and have about $8,850 per month to spend.
When Trish reaches 65, she will lose the $ 9,268 bridge from her pension but gain $ 7,362 from Old Age Security and an estimated $ 13,213 from the Canada Pension Plan. The couple’s income would rise to $139,377. With splits of eligible income, they would pay tax at an average rate of 20 per cent and have $9,400 per month to spend.
COST AND
TAX MANAGEMENT
At each stage of retirement, they have enough to meet their income goals without tapping into their home equity or their non-registered assets, which are significant.
They have $250,500 cash earning one per cent and $430,000 in GICS earning perhaps two per cent. They could use some or all of that money to buy a condo and a boat somewhere warm, and should have enough wiggle room to cover the additional expenses that come with them. If Trish and Ellis do buy that house south of the border, they will need to observe U.S. rules on deemed residence and tax exposure, and should consult an expert in that regard.
If they do not buy, they would be wise to maximize their contributions to their TFSAS, in order to avoid any risk of triggering the OAS clawback, which kicks in when net income rises over $79,054 per year per person.
They could also free up more savings by gradually switching from high-fee segregated funds to low- cost exchange traded funds with similar holdings. ETFS with average management fees of 0.2 per cent would save them 2.2 per cent of typical management fees of 2.4 per cent on their present mutual funds. On $ 300,000 of invested assets, that’s a saving of $6,600 per year. Some of their mutual funds are clones of indexes. They pay for copycat management that mirrors markets. “Sell them and buy ETFS,” the planner suggests.