Migrating to retirement
SITUATION Incomes will decline before public pensions begin to flow STRATEGY Use non-registered cash as bridge to pensions SOLUTION Secure retirement, with limited discretionary income
In Toronto, a couple we’ ll call Louis, 57, and his wife, Helena, 54, are real estate agents. In that bubbly market, they bring home $12,813 a month after tax.
They have two children in their 20s, both recent university graduates, living at home. It’s a good living, but they want to quit the hustle and hassle of peddling houses. Their problem is managing the transition to retirement.
The exit Louis and Helena want to make from their real estate business will be gradual, allowing their monthly income to slow to perhaps $11,000 in 2012, $7,000 a year later and $5,300 in 2014. The question is whether their $6,125 monthly expenses can be sustained, even if they scrimp on home maintenance and finish paying their one debt, a car loan that costs them $534 a month and that will be gone in two years.
Their careers have been rewarding. With a little over $1-million in financial assets and a house that is mortgage-free, they want to know if they can afford to retire. “Do we have the asset base to exit our business and to live comfortably or should we stay with our business for a few more years?” Louis asks.
Family Finance asked Caroline Nalbantoglu, head of Cnal Financial Planning in Montreal, to work with Louis and Helena. “They make a very good salary in their real estate business and have managed income-splitting to reduce their taxes. The problem, however, is going to be sustaining their high rate of savings — as much as $25,200 per year on top of $44,900 per year to their RRSPS and $10,000 per year to their TFSAS. Once they slow down, they will not have the surplus or the opportunity to make all of those savings,” the planner says.
BOLSTERING RRSPS BEFORE RETIREMENT
In preparation for retirement, the couple should take full advantage of their RRSPS. The contribution limit is set by earned income in the previous year. So next year, with a lower income, they will have perhaps $18,000 each of RRSP room. They should top up their plans to those limits. When they withdraw funds, they should be in lower tax brackets, so they will achieve tax savings, Ms. Nalbantoglu says.
By Louis’s age 61, when he and Helena will have stopped working, they will have $573,000 each in their RRSPS and $66,000 in their TFSAS, the planner estimates. They will have spent funds from their non-registered assets which will then have declined to $108,000, Ms. Nalbantoglu says. Non-registered assets will be the bridge to full retirement in the critical few years before they can draw on the Canada Pension Plan.
If Louis and Helena do retire at his age 60, as they plan, they can
Retirement with no company pension plan and a healthy but limited portfolio of financial assets will make the couple dependent on the success of their investments
make early application for CPP benefits. If Louis earns income after age 60, he will have to contribute to CPP. Self-employed, he will have to make both the employer and employee contributions at 9.9% of income up to the year’s maximum pensionable earnings level, $50,100 a year in 2012. He will pay a penalty of 0.056% per month for each month prior to age 65 that he begins benefits.
If Louis were to convert his RRSP to a RRIF at age 61 and withdraw the minimum amount from it each year, his combined RRIF and CPP income would be about $27,600 in future dollars. If Helena were to take a similar amount from her RRSP without converting to a RRIF, their combined after-tax income would be about $42,000 a year.
Their expenses in retirement, which Louis estimates would be $64,500 a year, will leave them $22,500 short. They can use their non-registered assets to cover the deficit.
They will have a similar shortfall the next year. When Helena starts receiving her Canada Pension Plan benefits of $5,500 a year, the deficit will decrease to $17,000. They can continue to use up their non-registered savings. Louis will start receiving Old Age Security benefits that will have risen with indexation to $7,646 a year when he is 65. Helena will just make it into beginning slightly higher OAS at her age 65 under recently announced government plans to change OAS qualification ages.
If they can hold down expenses until they both receive OAS, their finances will be more secure, Ms. Nalbantoglu says. Louis and Helena will have sufficient income for their retirement, but they should not shut every door to returning to work on perhaps reduced hours.
They should also endeavour to get more income out of their assets. They can expect a 5% return on all assets, 2.5% from capital appreciation and 2.5% from interest and dividends.
Bond interest rates are going to rise in the next few years. They can wait to reshape their portfolios to capture those rates or use a laddered portfolio of government bonds or perhaps a bond exchange-traded fund with a ladder of maturities from one to five years or one to 10 years. There is a significant jump in interest rates after five years, but also more exposure to the probable decrease in bond values as rates rise. Fresh bonds will eventually offer higher rates than old bonds, which will, in course, sink in price.
The portfolio structure is quite unaggressive. It trades stability for growth. The income the couple can expect will be modest, but cushioned by lower tax rates, especially if they have a significant weighting in preferred stocks whose dividends qualify for the dividend tax credit.
“Retirement with no company pension plan and a healthy but limited portfolio of financial assets will make the couple dependent on the success of their investments,” Ms. Nalbantoglu says. “So this retirement plan is really about discipline and structure. If Louis and Helena get that right and stick to this plan, they should have a secure and comfortable retirement.”