COUPLE NEEDS TO EMBRACE INVESTING, SELL ASSET

Raise returns by shifting massive cash holdings to stocks, eventually sell U.S. vacation home

In Alberta, a couple we’ll call Gus, 59, and Linda, 56, are trying to come to terms with retirement. Gus has a nervous system illness and has been on disability for two decades. Linda, a manager for an information services company, wants to retire in a year or less. She has fought and won a battle with circulatory disease. When she retires and gives up her $180,000 annual salary, the couple will have to get by on savings to produce what they hope will be $60,000 a year after tax. Their question: Will their assets provide that income? With the way their assets are currently invested, the answer is no.

Given their medical issues, their problems link the longevity possible in a medical sense and what is attainable in a financial sense. Gus will remain on disability until he is 65, then shift to reduced CPP retirement benefits. Their children are grown, gone and independent. However, financially, Gus and Linda are on their own, for neither has a defined benefit pension. The security of their retirement will depend on just a little over $1 million in financial assets, all of it in RRSPs and TFSAs. They have a mortgage-free U.S. vacation property with a market value of C$265,000.

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“Can we retire given our current expenses?” Linda asks. “Really, my wish to retire soon is driven by my concern for my husband. However, he is unsure that we have enough money for me to quit work.”

Family Finance asked Jim Cripps, senior financial planner with Vancouver Financial Planning Consultants Inc., to work with Gus and Linda. His view is optimistic. “They have sufficient assets to sustain them if they adjust their investments to raise their returns,” he says.

They have to follow through with the sale of their U.S. vacation property to sustain their retirement income, Cripps adds. They plan to keep it, using the property for four months of the year for the next 16 years, until Gus is 75. Until then, it is a financial dead weight that provides a place to stay for the months that they do not rent it out. The $1,100 monthly rent they charge covers costs of $1,040 a month for condo fees and utilities with no reserve for vacancy or maintenance.

THE PRESENT BUDGET

The couple spends and allocates $7,980 a month, of which $4,220 a month is the CPP disability payment for Gus. Looking ahead, if retirement savings, in the form of Linda’s $1,800-monthly RRSP contributions and TFSA contributions of $1,000 a month, are removed and food and travel each cut by $100 a month, the reduced budget is just $4,980 a month. At this rate of expenditure, they could get by on about $67,000 a year of private savings investment returns and government pensions. With a split of eligible pension income from registered retirement income funds and no tax on TFSA payouts they could pay 10 per cent average tax and support monthly spending of $5,025, indexed to the rate of inflation Cripps says.

With their current asset allocation, Gus and Linda will have pre-inflation adjusted gross investment income of about $30,000 a year. If he starts CPP benefits at 60, he would have to take a permanent 36-per-cent reduction from the $915-monthly CPP he would otherwise get by waiting to 65.

With that penalty figured in, their income before tax next year, when Linda will have quit her job, would be $35,562 of which $5,562 would be CPP benefits for a partial year after Gus turns 60. They will need to draw about $25,000 from savings to get to the $60,000 their retirement budget requires. The following year, Gus would get CPP benefits reduced for starting at 60 of $7,030 in 2015 dollars, making total annual investment income $37,030 plus $23,000 taken from savings. If Gus waits to start CPP until age 65, when he would get $10,980 a year, they would have to draw down five times the $30,000 capital needed to boost spending to $60,000 a year. That would be an unacceptable $150,000 reduction in their retirement capital, Cripps says.

In 2019, when she is 60, Linda would take her CPP benefits, $994 a month, pushing up CPP for the couple to about $19,000 and reducing the annual draw on capital to about $11,000. When Gus is 65, he would get Old Age Security benefits of $6,778 in 2015 dollars, Linda, at her age 65, would also get OAS. Their total income would be about $60,560 before nominal taxes. In fact, given an assumption of 2.5-per-cent annual inflation, their purchasing power would have eroded by a fifth by the time Linda gets her OAS, Cripps notes.

RAISING RETURNS

Gus and Linda have a preference for low risk investments. Just $200,000 of their $950,000 RRSPs is in common stocks. The rest is mostly cash with a near zero return and bonds with a return of barely one per cent after inflation. They could move $500,000 of RRSP assets to stocks with six per cent blended dividend and price appreciation, take off 2.5 per cent for inflation and have a return of 3.5 per cent. That would boost annual portfolio returns by $17,500, reducing the drawdown of capital.

There is a better way to reduce their financial pressures with ease: If the couple were to annuitize their RRSP and TFSA savings of $1,060,700 with a 3.5 per cent average return so that all capital is paid out by the time Linda is 80 they would have $66,000-pre-tax investment income. That would allow Gus to postpone taking CPP to age 65 and boost subsequent income by the $4,200 difference between early draw at 60 and full entitlement at 65.

Their mid-retirement income could be increased by the planned sale of their $265,000 vacation property when Gus is 75 and Linda is 72. The property should increase in value by an estimated two per cent a year for 16 years to $364,000. Take off five per cent selling costs and they would have $345,800 more to carry them through their retirement.

They could annuitize that sum conservatively with a 20-year horizon to Linda’s age 95 to obtain a further $21,800 of annual income. There would be a period when two annuities were running together, allowing the surplus to be saved should either live longer. Finally, if Linda or Gus survives the end of their annuities and potential reserved income, they would still have indexed CPP and OAS and their house to sell. Projections depend on realizing 3.5 per cent on invested capital after inflation.

BALANCING RISKS

Gus and Linda must weigh their distaste for wobbling stock markets with their need to keep up with inflation. The longer they live, the greater will be their inflation-driven jeopardy of losing purchasing power. Annuitized payouts will raise and guarantee income for their retirement. They can shop insurance companies for annuities or set up RRIFs for their RRSPs, which hold most of their money, with payouts similar to those set by annuity formulas.

“They would keep their Canadian home as a final source of capital if they need money to provide for assisted living after their annuitized savings have run out,” Cripps adds.