COUPLE NEEDS TO GET THEIR BUDGET UNDER CONTROL OR RISK OVERSPENDING IN RETIREMENT

Add up personal financial assets and job pension, compare to costs, boost returns

Acouple we’ll call Hilda, 54, and Ernest, 58, live in Ontario. They have good jobs, his with a large company with a defined benefit pension, hers part time with a local government that provides no retirement benefits at all. Their children are in their mid-20s and have independent lives. Hilda and Ernest are financially secure now, but unsure of the future. Their question — will they be able to retire comfortably?

“Will our current investments be enough to maintain our current standard of living?” Hilda asks. “And just when should we retire?”

Family Finance asked Benoit Poliquin, chief investment officer of Exponent Investment Management Inc. in Ottawa, to work with Hilda and Ernest. “They are diligent in saving and cautious in spending. And they are willing to work more years if they must,” Poliquin says.

The problem at this point is income prediction and investment analysis to determine the productivity of the couple’s financial assets. Their lifestyle is modest in terms of their resources. But stretching their savings for what could be four decades is a concern.

At retirement, they will have expected monthly i ncome of $ 4,705 from Ernest’s job pension plus a $ 964 bridge to 65. The pension is fully indexed to the consumer price index. They will also have investment income from present financial assets of $ 376,800, plus a $ 60,000 severance payment Ernest will receive when he quits. Part of it can be sheltered in an RRSP. The financial assets with the severance payment add up to $ 436,800. At three per cent after inflation, that capital would generate $ 13,100 a year, or about $ 1,100 a month.

When Ernest is 60, his retirement target date, their starting monthly retirement income would be $ 6,769 before tax. After 15 per cent average income tax ( 18 per cent on his large income, five per cent on her smaller income), they would have $ 5,754 a month to spend. It would support present monthly expenses of $ 5,634 a month less savings and leave a surplus. At 65, they can draw CPP benefits — Ernest’s of about $ 930 a month, Hilda’s of an estimated $ 266 a month — but will lose Ernest’s $ 964 bridge. That would make total income at this point $ 7,000 a month before tax. When each is 67, they can add OAS benefits of $ 565 a month each. Their sustainable retirement income would then be about $ 8,130 a month before tax or — using the same 15 per cent rate for consistent comparison — $ 6,900 a month to spend. They would be able to support present allocations and add money for travel or other pleasures. Most of their income will be indexed by Ernest’s pension plan, by CPP and OAS adjustments and by estimation of post- inflation returns.

ASSESSING NEEDS

They would seem to have no financial issues in retirement. But that’s just from the overview of their earning and spending. If we dig down into their accounts, several problems are evident.

To start with, they do not track their expenses accurately. Their reports of their monthly restaurant spending have a $ 100- to-$ 250 range. Travel has a $ 100- to-$ 200 monthly range. Entertainment is somewhere between $ 40 and $ 100 a month. Just these categories add up to a potential variance of $ 3,720 a year — enough to move the budget balance from black to red. In our analysis, we have averaged costs in their reporting.

They also need to review life insurance costs. Ernest and Hilda maintain a $ 480,000 life insurance, plus $205,000 as a benefit with Ernest’s job. The premiums on their own policies are $ 150 a month — not a lot, but apt to rise dramatically when their term policies are up for renewal. They don’t need the coverage; they have no debts and their expenses are within budget.

They need to test the effect on their retirement spending of gifts to their children. Before retirement, Hilda says, they would like to give each of their two adult children $ 20,000 for home improvements, then spend $ 18,000 for two new or good used cars for the kids. The potential gifts add up to $ 76,000. If that sum is deducted from their $ 436,800 capital, they would be left with $ 360,800. At three per cent after inflation, that sum would generate $10,800 a year. That’s $2,300 a year less than the investment return on the unreduced capital. On a monthly basis, the gap would be $ 190. Over 30 years of retirement, even ignoring compounding on this notional sum, it would add up to $68,400. And that, as they say, is not chicken feed.

MANAGING INVESTMENT AND LIVING COSTS

Hilda and Ernest can raise their incomes in retirement by using an annuity payout calculation for their retirement incomes beginning in two years. Disregarding interim interest, which could be changed by improved bookkeeping, the annuity calculation for 35 years beginning when Ernest is 60 and running 39 years to Hilda’s age 95 gives them $ 18,600 a year if their capital is intact or $15,400 if they give their children $ 76,000 when their retirement begins. The base difference, $ 3,200 a month, could be accommodated or eliminated just by shortening the theoretical payout period to 30 years. In any event, the annuity calculation would boost pre- tax income over the straight three per cent annual payout by $ 7,800 a year if they do not make a gift to their children, or by $ 4,600 if they do.

They can add to their retirement income by cutting costs on their many mutual funds, some of which have fees of 2.8 per cent of assets under management. A switch to exchange- traded funds, some of which have fees of a 10th of a per cent a year, could save two per cent or, at the $430,000 asset level, $8,600 a year.

Ernest and Hilda need to take control of their accounts. A course in bookkeeping or use of an expense tracker program — they are the price of a couple of cappuccinos a month, and some are free or included with some computer software packages — would be immensely helpful.

“They have money to live much as they do in retirement,” Poliquin says. “They have capital, they have liquidity, they have Ernest’s job pension, but what they do not have is control. If they fix that, their retirement will be secure.”