Failure to be critical investors costs couple
Use annuitized payouts of investments to boost CPP and OAS, study investing to avoid scams
In Alberta a couple we’ll call Max, 70, and Teresa, 68, live on $4,600 a month. They supplement their Canada Pension Plan and Old Age Security benefits with Max’s part-time construction work when his back permits and Teresa’s part-time nursing work. They have a dog. Their takehome income is a little below average for retired couples with four grown-up children, but theirs is not an average situation, because they are raising a disabled teenage cousin we’ll call Sandy. They get tax credits and Sandy has a Registered Disability Savings Plan, but Sandy’s needs make their situation financially difficult.
Their incomes are limited and they have a home-improvement $17,066 interest-free loan to repay. It’s a grant from their city with no interest, but it has to be repaid if the house is sold before 2033. However, if the house is not sold, the loan is forgiven. Their plan is to stay. Given their modest income, the money they expend on Sandy and their own needs for retirement, they are concerned that can’t afford to stop working.
“We do not want to be old and living in poverty,” Teresa says. “Our four adult children have offered to help us, but they are raising families of their own and we do not want to be accepting money from them. Freedom 55 passed us by. We are now thinking of Freedom 75.”
Family Finance asked Derek Moran, head of Smarter Financial Planning Inc. in Kelowna, B.C., to work with Max and Teresa. “On the positive side, they are both in good health and are comfortable living on a relatively modest income,” he says. “They have relatives who have lived to their 90s, they have a house with no debt other than an interest-free grant, and a handful of investments in their accounts. On the negative side, there isn’t much room for error. Unless they make changes in the way their capital is paid back to them, they face a strained retirement.”
Retirement math
When Max and Teresa retire fully, they will be left with $12,648 combined CPP benefits and $13,530 combined OAS benefits. They can obtain income from $12,313 of existing RRI Fs, $31,500 of taxable investments, $60,000 of existing TFSA s and $21,500 cash yet to be invested.
These investment funds, which do not include Sandy’s RDSP, add up to $125,313 and can produce steady income at three per cent over inflation of $3,760 a year, pushing total family income to about $29,938 a year, or $2,495 a month.
Given that much of their investment income will come from the TFSA s and thus not be taxable and that they can use the pension income credit of up to $2,000 RRIF income, they will have little or no income tax to pay.
Max and Teresa are frugal. Their monthly expenses and savings, $4,600, should drop to $2,523 when they cease work and when Sandy leaves home. They will be able to save $760 a month they spend on child care, $747 they put into the TFSA and other savings and $250 of groceries when there are only two at home rather than three. They can also eliminate one car, saving $150 a month on gas and insurance, and eliminate $170 a month for life insurance premiums for two $100,000 10-year level term policies whose premiums will soon soar.
The policies will not be needed when Sandy becomes independent in a few years. Until Sandy does leave home, Teresa should stay at work, Moran suggests. Her $1,000 a month net take-home income will be needed to bridge the gap, Moran notes.
To increase retirement income, the couple’s financial assets, not counting the RDSP , could be annuitized to pay out all income and capital by the time Teresa is 95. That way, the portfolio could generate $6,638 a year, making total income $32,820 a year, or $2,735 a month in 2015 dollars.
The $240 monthly income gain produced by the annuitized payout will be their cash cushion for unexpected expenses and, later, a newer used car.
Understanding investing
Max and Teresa have been taken advantage of by several astonishing schemes from different advisers. They were persuaded to mortgage their paid-up house, then invest the cash proceeds in a leveraged collection of mutual funds with high management fees on top of their borrowing costs. They also withdrew money from what was then $60,000 of RRSPs to pay the interest on the investments, which were taxable outside of RRSP s, and borrowed $225,000 on a home-equity line of credit to buy more mutual funds. They added other debt and, with returns eaten up by those costs, suffered substantial losses.
Even their TFSA s were bulked up with contributions of assets from taxable accounts. When shifted to TFSA s, assets were subject to capital gains tax.
Faced with massive loan costs and having learned the consequences of poor advice, they closed out the loans and sold the assets bought on credit. Their experience shows the results of taking on risks not clearly understood.
Trust and generosity are wonderful qualities in any person, but in financial markets, trust has to be matched by critical thinking. Whether to buy, to sell, to trust or to slam the door on sales pitches takes at least enough knowledge about risk and return to separate potential winners from scams. Failure to be critical investors cost the couple dearly. They need to become well versed in finance — not to be expert portfolio managers, but to know what to ask those who want to sell them investments, Moran says.
Max and Teresa have the intellectual capacity and the demonstrable need to study capital markets by taking an investing course at a local university or college or spending time at their local library reading economics, accounting, reviewing math and statistics, and, of course, studying the financial press, especially the Financial Post — we can toot our own horn here — for information from people who don’t want to take their money. “The small amount of money they might spend on books or library fines and time spent studying could be the best investments they ever make,” Moran concludes.