Layoffs and declining property values put pair’s retirement to the test
ESTIMATED CURRENT VALUE OF RENTAL HOME $625K
In Alberta, a couple we’ll call Liam and Ruth, both 60, were shown the door in their respective professions of electrical engineering and management consulting. They have been retired by circumstance rather than by plan since 2015.
Out of work, they are in a financial bind. A total of 63 per cent of their assets are in real estate. A rental property the price of which collapsed by 31 per cent in Alberta’s boom/ bust economy produces a zero return after mortgage and other costs. Their $750,000 house also produces no income. They have $266,688 in staggered five-year GICS and $513,929 in RRSPS, but 87 per cent of the latter is in Locked-in Retirement Accounts (LIRAS). They also have $1,270 in TFSAS but that’s not enough to pay their bills.
Liam has a $12,960 annual job pension. That pension plus income they get from their GICS generates current total pre-tax income of about $18,275 per year. They add to that income with drawdowns from their RRSPS.
If they apply at age 65, Liam’s Canada Pension Plan benefits will pay him $5,400 per year Ruth will receive just $3,500.
Family Finance asked Eliott Einarson, a financial planner who heads the Winnipeg office of Ottawa-based Exponent Investment Management Inc., to work with Liam and Ruth.
“This couple has to face the reality that they will not find jobs that replace their former professional incomes,” Einarson explains. “They estimate that they will need $50,000 after tax per year or $4,167 per month.”
Forced into an early retirement, they want to know if they should accept their fate or seek work even at entry level wages to generate cash. The issue — current income is about $5,400 per month less than their monthly spending of $6,959.
SCANT RETIREMENT RESOURCES
Ruth has no job pension. At 65, Liam will be entitled to Canada Pension Plan benefits of $350 per month, Ruth to CPP benefits of $205 per month. They will have reduced Old Age Security benefits totalling $705 per month for 23 of the 40 years residence in Canada required for full benefits.
Their situation is grim but not hopeless, Einarson explains. There are short-term solutions, though each has a downside. Their $266,688 in GICS coming due over the next five years can sustain their spending, but that will mean running down their assets. Starting CPP at age 60 would provide a cash flow of 64 per cent of the $555 combined monthly sum they will receive at 65. That reduced sum would be $355 per month, a $200 discount that is modest today but that will impair future payouts. It would not solve their problem.
RAISING CASH
They have to unlock wealth in real estate. They should sell their rental property which generates no return after mortgage and other costs. They bought it for $910,000 in 2008. It has an estimated current value of $625,000, 31 per cent less than they paid. It has a $545,000 mortgage balance. If they were to sell for current price less five per cent selling cost, and pay off the mortgage, they would net $48,750. That sum invested in diversified financial assets at three per cent over the rate of inflation would generate $2,200 in 2019 dollars per year for 35 years to age 95.
They should downsize their house. If they were to sell for 95 per cent of its estimated $750,000 price, they would have $712,500. They could keep $500,000 for a smaller house or condo and invest the $212,500 difference. At three per cent after inflation, that capital would generate $9,600 per year for 35 years.
ESTIMATING RETIREMENT INCOME
The couple’s RRSPS, which hold a total of $513,929, growing at three per cent per year over inflation, can generate $23,221 for 35 years to the couple’s age 95 at which time all income and capital will be exhausted.
The couple’s non-registered assets, GICS that total $266,688 growing at three per cent per year after inflation for five years to $309,170, then invested in non-locked in assets and annuitized to pay out all income and capital for the 30 years to their age 95 would generate $15,315 per year.
We’ll add up the components of retirement income starting with the sale of the dead-in-the-water rental and downsizing their house. Before age 65 the couple would have Liam’s $12,960 job pension, $23,331 from RRSPS, $9,600 from house downsizing and $2,200 from selling the rental. That’s a total of $48,091 before tax. After splits of eligible income and nine per cent average tax, they would have $3,646 per month to spend. That’s less than their $4,167 monthly target. But with no mortgage cost and realty tax bills reduced to $200 to $300 per month for a smaller home, their cost of living could drop to about $3,000 per month, well within income, Einarson estimates.
At age 65, they could add $15,315 from matured GICS and reinvested in dividend paying stocks or balanced stock-bond portfolios generating three per cent per year for the following 30 years. They will have combined CPP benefits of $8,900 and $8,456 Old Age Security. Their total post-65 income would rise to $80,762. With eligible income split, they would pay tax at an average 16 per cent rate and have $5,655 per month to spend to age 95. At 95, even if their invested capital runs out, they would still have Liam’s company pension, CPP, OAS and a $500,000 house that might have appreciated in the intervening decades. They might also have enhanced their TFSAS with their growing surplus, Einarson notes.
Transition to investments in financial assets and out of their over-allocation to real estate would cut portfolio risk. They would still have a home which, at $500,000, would be about a quarter of their total assets at current prices. They could put money into real estate investment trusts. The REITS could be diversified by type of property or region. Diversification perhaps via mutual funds or ETFS would lower investment risk and raise income.