No part-time work wanted

Couple lacks enough income to close business and retire,

Far from the bustle of Bay Street, a couple we’ll call Hubert, who is nearly 62, and Fiona, who is 57, want to shut the doors on their health care products company and retire. In their small Ontario town they live well on $8,400 takehome monthly income. They have a $300,000 house and two nearby cottages for themselves and their brood of children, spouses and grandchildren. Their problem — translating their relative affluence in rural Ontario into the world of travel they hope to do.

Sustaining their pleasant way of life before either can draw CPP without reduced benefits and as much as eight years before Fiona can have Old Age Security will be challenging. Complicating the problem is a $573,000 portfolio of neglected financial assets. They nevertheless want $60,000 a year after tax when they retire. “That would be enough for our retirement,” Hubert says.

“We think that when we shut the doors to our business, we’ll travel and pursue our hobbies and sports.” They are not interested in part-time work, nor does their line of business make that a possibility.

“After forty years in our work, we want to call it quits.”

Unfortunately, the couple’s investments lag their plans, says Benoit Poliquin, a financial planner and chartered financial analyst who is lead portfolio manager of Exponent Investment Management Inc. in Ottawa.

“At the moment, their portfolios are heavily in cash and GICs with the balance in mutual funds whose names they do not recall. They have not gotten around to making RRSP or TFSA contributions in recent years. So this is a portfolio management problem as much as it is one of sufficiency of resources. But they have two strengths — they are relatively young and they have abundant cash to invest.”

TIMING RETIREMENT

Immediate retirement is not possible given their income goal. Their financial assets generating 3% a year after inflation will produce only $17,190. Even if Hubert made an early application for CPP benefits, he’d get just $8,950 a year. The sum, $26,140, would be insufficient.

If they wait until Hubert is 65 they would have his full $11,424 CPP benefit and Old Age Security, $6,660 a year. Fiona could take a reduced CPP benefit at that time of $6,612 a year. They would have investment income of $17,190 a year before tax. The total, $41,886 before tax, which would be negligible if they split CPP benefits and what would be RRIF pension income, would still be far from their goal. Fiona can add her OAS at 65, which would push total pre-tax retirement income to $48,546 a year in 2013 dollars.

At present, the couple’s investments are $305,000 of mutual funds in RRSPs, $250,000 in guaranteed investment certificates with yields of 2% to 3% held in their business, and $18,000 of Tax-Free Savings Accounts completely in cash.

Hubert and Fiona save $5,400 a month or $64,800 a year. They have $120,000 contribution room in their RRSPs. Assuming that they continue to work four more years until Hubert is at the end of his 65th year and make annual contributions to fill up the space and then use all of their $21,600 yearly RRSP limit, they can put a total of $206,400 into their RRSPs.

On top of $305,000 currently in their RRSPs, they will have approximately $571,400 in their RRSPs at the time they retire. Money for contributions will come from $224,000 currently held in GICs that can be paid out of their company, though with potential tax consequences, as the certificates mature over the next three years. The RRSP contributions will produce refunds, which, based on their average tax rate, would be about $25,900.

That money could be directed to Tax Free Savings Accounts and enhanced with $5,500 a year of cash per person from monthly savings in order to utilize TFSA space. In four years, the couple would then have $72,000 TFSA dollars available for spending with zero tax payable.

By delaying retirement to the time Hubert is 65, the couple will have investment income of $17,140 from their RRSPs paying 3% per year after inflation, $ 2,160 from TFSAs on the same basis, $11,424 a year from Hubert’s CPP, $6,612 from Fiona’s CPP with a discount for early application, $6,660 from Hubert’s OAS, and miscellaneous income such as $450 from a tax-free $15,000 disability settlement due in 2014. Their approximate pre-tax income will be $44,450 until Fiona is 65 when her OAS benefits will push total income up to $51,100 per year before tax. They will still not have attained their income goals, but they will be close and able to close the gap.

ASSET MANAGEMENT

If they raise the payout rates from their RRSPs, then, using a 6% average payout rate, their RRSP income would rise to $40,920. Adding in CPP and Hubert’s OAS, they would have $68,226 of pre-tax income. Fiona’s OAS would push total annual income to approximately $74,886. After average 15% income tax, they would have about $63,650 annual income after tax in 2013 dollars. They would have met their retirement targets. In the five years between Hubert’s age 65 and Fiona’s age 65, the couple can tap their capital to make up any shortfalls or delay the extensive travel they plan, Mr. Poliquin suggests.

The critical variable in these projections is the rate of return on invested assets.

Hubert and Fiona’s problems are timing retirement and raising investment returns. They cannot afford to retire immediately. Thus they need to work to 65 in order to generate the RRSP capital they need to produce cash flow which, with CPP and OAS, will meet their requirements. By waiting until Hubert is 65, they will have a pleasant and secure retirement, Mr. Poliquin says.