DIVORCED AND ANXIOUS AT 59
In Alberta, a woman we’ll call Adele, 59, is adjusting to independent life after her divorce last year. She has a career as a management consultant. Her two children are grown and gone, she has a home of her own and a job that pays $72,000 a year. She also rents an apartment in her home for $9,900 a year. Her $5,200 monthly after-tax income supports a frugal way of life.
“I find myself at a crossroads,” Adele explains. “With all the changes I went through last year, now it is time to refocus on what I want and what I need to do. Timing when I retire is an issue, as is timing the sale of my house or keeping it. I would like to do it next year when I am 60. Can I make it work?”
Family Finance asked Derek Moran, head of Smarter Financial Planning Ltd. in Kelowna, B.C., to work with Adele.
Her priority is to enhance her financial security. Part of that is cost management and part is capital management.
Adele’s single largest asset is her $600,000 home. Her largest liability is the $274,604 mortgage with a 3.09 per cent interest rate. The house is 44 per cent of her assets. If she were to downsize, she could cut monthly expenses of $1,410 for her mortgage and have lower property taxes, utility and other costs.
Her house is a bargain, because her mortgage cost is offset by the $825 a month she receives from her tenant. That leaves a net cost of $585 a month, or $7,020 a year, which is about one per cent as the direct cost of occupying the house. But going into retirement with a large debt is not wise, so downsizing is good for risk management, Moran cautions.
If she downsizes to a $300,000 house or condo in a small town in southern Ontario, as she contemplates, then pays off her mortgage, she could have $300,000 clear for a property purchase. .
Adele’s financial assets are not so simple. She has a major insurance company’s variable annuity with guaranteed income for life, creditor protection and periodic asset resets that lock in gains. The annuity’s current value is $281,218. Its protections are valuable but it has management surcharges of about 0.75 per cent on top of fees for the actual investments around which the annuity is wrapped.
She also pays 4.5 per cent for a $63,200 home equity line of credit. It should be prime plus half of one per cent. On that basis, she could save at least one per cent, or $630 a year. She should push her lender for a fee cut or take her loan elsewhere, Moran suggests. These savings are vital to raising her cash flow and ability to retire.
Inside her RRSP, among other assets, Adele has a $147,232 investment in a mortgage company. The yield of eight per cent of her cost is good, but the investment amounts to nearly a fifth of total financial assets.
Were the mortgage company to get into deep water and be unable to pay her interest or to refund her capital, she would be in trouble. Reducing the allocation to the mortgage company to perhaps 10 per cent and putting money withdrawn into a few conservative real estate investment trusts would cut her risks.
Adele also has a $100,000 universal life policy, which is a conventional life policy with an investment component. In Canada, these companies are backed by the insurance industry bailout fund Assuris, as well as strict regulation by the Office of the Superintendent of Financial Institutions. There is little risk of failure for policyholders like Adele.
Right now, Adele has incomeproducing assets of about $758,000. Her substantial management fees averaging 2.5 per cent will cut into our usual estimate of a six per cent return before three per cent inflation, so we’ll use two per cent over inflation as her rate of return on invested assets.
On that basis, Adele would have $773,000 at age 60 with a year’s interest. With the same rate of return and spending all income and principal to age 90, she would have cash flow of $34,000 a year. She says she would be happy to work at a minimum-wage job for more cash if needed.
At 65, she will be eligible for an estimated $12,000 of CPP benefits a year for total pre-tax income of $46,000. Old Age Security at $6,765 a year would raise her income to $52,765 a year before tax. Assuming her new residence is paid for, her expenses (reduced by the elimination of the mortgage) would be $2,839 a month. They would easily be covered by income after 17 per cent tax of $3,650 a month.
Retirement at 60 is possible, but more income is readily attained by raising returns or capital available for investment.
Switching from conventional mutual funds to a portfolio managed by an independent adviser for a more modest charge of one to 1.5 per cent of assets under management, Adele would save one per cent a year or more. A one per cent increase in returns via fees saved translates as 16.6 per cent of a portfolio with a gross return of six per cent, Moran notes.
Adele does not need her life insurance policy. Her children are independent and self-supporting. If she terminates the policy, she could harvest cash value of $13,650 and put the money into her RRSP, boosting total financial assets to $786,650.
Using annuity figures with capital increased by cashing in the life policy, her total income, including government pensions from age 65 on, would be $53,165 with a two per cent rate of return, or $57,765 a year with the three per cent annual return.
After 17 per cent average income tax, she would have monthly disposable income of $4,975 in the two per cent return case, or $5,294 a month in the three per cent return case. With rising income and presumably rising savings, Adele could park her savings in a Tax-Free Savings Account, which would provide investment opportunities and easy withdrawal.