National Post

OIL CRASH PULLED THE RUG OUT FROM UNDER COUPLE’S RETIREMENT PLANS AND THEY NEED A FIX — FAST

Solution: Cut expenses, sell unproducti­ve investment, cut advisers’ fees, annuitize investment­s

- Andrew Allentuck ( Email andrew. allentuck@ gmail. com for a free Family Finance analysis]

In Alberta, a couple we’ll call Gary, 60, and Wendy, 67, made their home a-nd grew prosperous with Gary’s decades of work in the oilpatch. A petro chemical engineer, he earned as much as $200,000 a year doing consulting, spending $ 890,000 on rental properties and piling up about $ 595,000 of financial assets. Wendy worked as an administra­tive assistant earning $24,000 a year before she retired in 1990. The consulting income is history, a casualty of collapsed oil prices and the energy industry’s slump. Wendy draws $1,110 a month of combined Canada Pension Plan and Old Age Security benefits. Gary gets $ 475 a month from CPP. Add in some rental income that brings in $590 from their two rental properties and their total income, $2,175 a month, is $3,240 less than their expenses. They need a fix and it has to be fast. “I am not sure what the future will bring,” Gary says. “We need to know if we can survive.”

Family Fin- ance asked Guil Per reault, a financial planner with the Foster Agency in Winnipeg, to review the couple’s finances. His recommenda­tion —- get rid of a money losing rental prop erty, cut expenses and reallocate assets to cut investment costs. “They have the ability to fix their finances and, if they get started, odds are they will succeed,” Perrault says.

MANAGING ASSETS

The largest problem is that the couple’s income properties, which make up 60 per cent of their invested assets, produce little cash flow. One unit is rented to the couple’ s son and its $ 1,150 monthly rent is below market rates. Their mortgage alone is $ 673 per month and has 21 years r- emaining. Property tax and insur ance raise their total cost to $ 992 per month. Gary and Wendy have no plan t-o raise the rent, even though there turn on the property is $ 158 a month before any reserves for repairs or depreciati­on. Its return on equity is less than one per cent.

Their other rental property generates $ 1,300 a month before expenses: $ 787 for the mortgage and $ 285 for taxes and insurance. The mortgage will be paid off in six years. When their tenant’s lease is up for renewal, w- hich is within a year, they should ne gotiate a new rent sufficient to cover total costs, Perreault recommends. However, even if the rent rises by half to cover their costs of $ 1,072 a month o-r $12,864 a year and provide a mar gin for depreciati­on and vacancy risk, the asset would have a net return of approximat­ely zero until the $ 787 monthly mortgage costs ends in 2021.

They would be better off selling and investing the estimated market price of the property, $ 430,000, less the mortgage, $ 58,000, for a net value o-f $372,000. Allow $20,000 for prep aration and selling costs and they could have $ 352,000 to invest in an exchange- traded fund of stocks that h- ave paid dependable and rising dividends for many decades, Perreault says. If they obtain growth of three per cent after inflation, they would have pre- tax income of $ 10,560 year. If they annuitize these funds so that all capital is paid out over 30 years to the time Gary is 90, they would have $ 18,427 a year before tax.

The couple’s investment portfolio h- as $ 596,238 in financial assets, in cluding a U.KS-. 401 retirement ac count worth $ 250,000 in Canadian f- unds. Almost 90 per cent of their fi nancial assets are in mutual funds, with average fees of 2.5 per cent, and the balance is in cash in various accounts earning one per cent at most. Their management fees are about $- 8,000 a year. They could save per haps two- thirds of those fees by using ETFs- bought through an online dis count broker. If their financial assets were then to generate 2.7 per cent after inflation, they would provide $ 16,100 a year before tax. If annuitized to pay out all capital over 30 years, they would have investment cash flow of $ 29,500 a year.

N-either Gary nor Wendy has a com pany pension. However, they have CPP and OAS. Wendy already receives $ 565 a month or $ 6,778 a year from OAS. Her CPP benefits provide $ 545 a month, or $6,540 a year. Gary receives $ 475 a month, or $ 5,700 a year, from CPP and will receive $ 6,778 from OAS w- hen he is 65. Their government pen sions add up to $ 25,796 a year. Added to potential investment income of $ 47,927 a year, they would have total, pre- tax income of $ 73,723. With splits of pension income and applicatio­n of age and pension income credits, they w- ould pay tax at a 13 per cent aver age rate and have $ 5,345 a month to spend.

INCOME AND SPENDING

At their present level of spending, $ 5,415 a month, their present income o-f about $1,971 a month ($1,585 of gov ernment pensions and their nominal $ 386 net rental income) leaves them with a $ 3,444 monthly deficit. With restructur­ing as recommende­d, their monthly deficit would shrink 90 per cent to $ 315 a month. They can turn that into a surplus by eliminatin­g one of their two cars, at a potential saving of $ 150 a month in operating costs, licence, etc. Other things that can be cut include $100 of entertainm­ent and $400 of food. Their total savings would be $ 650 a month and leave spending at $ 4,765 a month. They would have a nominal surplus of $ 580 a month that could be used for travel, on which they now spend nothing, or banked for eventual replacemen­t of their one remaining car.

T- here is more to do. Their port folio is poorly invested: Fixed income assets are in taxable accounts, which pay annual interest of as little as of 0.5 per cent, and almost a third of their assets are fully taxable GIs and bank accounts. They should be sheltered in RRSPs or TFSAs to preserve what little interest they pay. The couple has F-$47,000 of room for TSA contribu tions. It is only paperwork to transfer the taxable cash to fill the TSAs.

The couple has been generous to financial advisers: $ 172,000 of their money is in high- cost mutual funds in registered plans on which they pay management fees of as much as 2.5 per cent each year. By migrating money within the plans to ETFs with fees of no more than 0.5 per cent a year, they would raise total returns by almost $ 3,500 a year. Moreover, data show that index funds within ETFs beat managed funds over the long run.

“- This is a case of a couple whose fi nancial foundation — the Alberta oil business — has crumbled,” Perreault says. “When Gary generated an income of $200,000 a year or more, they could afford to ignore investment­s, rent properties below market value and spend freely. That has changed. If they reduce spending and boost investment returns, they can have financial security in retirement and maintain the way of life they know.”

This is a case of a couple whose financial foundation — the Alberta oil business — has crumbled. If they reduce spending and boost investment returns, they can have financial security in retirement and maintain the way of life they know. — Guil Perreault, financial planner

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