Frugal couple wants a retirement plan that can survive one of their deaths
Acouple we’ll call Geoff, 61, and Mary, 53, live in B.C. They have $2.5 million in assets, no liabilities and a pressing question — what is the most financially advantageous way to structure their retirement? They are frugal, thoughtful, but worried about what is to come. Their income in retirement will be heavily dependent on job pensions. But those pensions will not be enough to maintain their way of life. They need to develop their investments and to control investment fees.
Half of their net worth is in their $1.245 million house, the other half in a blend of registered investments, non-registered investments and cash. Their problem is not just attaining a retirement income goal, but maintaining income after death of the first partner. Their largest asset, the money run by pension funds, is not in their control. Building assets will remain a means to control their futures.
The good news in their financial lives is that they have no debts. Their house is fully paid and they owe nothing more than the credit card bills they pay promptly each month.
FUTURE INCOME COMPONENTS
Geoff has already retired from an administrative job. His monthly income is $3,648 composed of $584 CPP and $3,064 from former employers’ pension plans. Mary generates $4,880 per month before tax from two jobs in health care. Present investment income adds $2,300 per month for total monthly income of $10,828 before tax and about $8,320 after tax.
The goal is to sustain monthly after-tax income of $7,300, which is $1,020 less than present allocations. Their issue — is this level of income achievable and sustainable for what could be a three- or even four-decade retirement?
It’s important to dissect the couple’s investment incomes and job pensions to determine if Geoff and Mary can achieve and maintain their goal. Family Finance asked Graeme Egan, head of CastleBay Wealth Management in Vancouver, to work with the couple to calculate future retirement income. He notes that about twothirds of retirement income will come from job pensions. The critical problem will be to maintain steady investment income.
Mary wants to retire in two years at age 55. She expects to be fully retired at age 60. Mary will have two pensions. One pays $485 per month at 55 or $829 per month at 60. A second pension will pay $1,692 per month at 55 including a bridge to 65 or $2,318 per month at 60. She can add CPP benefits of $632 per month at age 60 or $886 per month at 65.
Geoff and Mary have $1,255,532 in RRSPs, TFSAs and non-registered accounts. If annuitized at three per cent for 42 years, that sum would generate $4,300 per month to Mary’s age 95. And $530 of that monthly sum would be untaxed TFSA cash flow.
When Mary is 55 in two years, she will have monthly pension income of $2,177 including $459 bridges to 65. Along with Geoff’s $3,648 monthly income, they will have a total of $5,825 monthly base pension income before tax plus $3,770 taxable investment income and $530 TFSA cash flow for total income of $10,125. After splits of eligible income, 17 per cent average tax and no tax on TFSA cash flow, they would have $8,500 to spend. They would surpass the target $7,300 per month with ease.
When Geoff reaches 65 in four years, he can add Old Age Security at $613 per month at present rates. That will boost monthly family income to $10,738. After splits and 18 per cent average tax, they would have $8,900 to spend each month.
When Mary reaches 65 in 12 years, she will gain $613 per month from Old Age Security. Her pensions will lose their $459 bridge to 65. She could add CPP of $988 per month. Family income would rise to $11,880 per month and after 18 per cent average tax they would have $9,840 per month to spend.
PROTECTING RETIREMENT INCOME
At present, their portfolio is mostly in one chartered bank’s mutual funds. They pay management fees up to 2.5 per cent depending on the assets managed. They could save money by shifting management to a private portfolio manager with lower fees. With a custom portfolio, in their non-registered accounts they would not pay taxes on their funds’ sales of assets to meet other fund investors’ demands for cash. Those sales can trigger gains for investors remaining in the funds even if their units have lost value. However, with a portfolio individually managed and thus not connected to other investors’ needs, this form of tax inefficiency could be avoided. The couple could ride out slumps without having to pay taxes for other investors’ needs.
The couple’s TFSAs, which have a present value of $154,832 including appreciation, are topped up. They can add $6,000 per year each going forward. The TFSAs will be a source of income should other sources fall short, Egan notes. Geoff and Mary’s $1.245 million house could be downsized to provide capital for investment to maintain retirement income. Investment income will be the backstop for drops in pension income caused by unindexed and inadequately indexed payouts failing to keep up with rising prices.
Their budgets will be stressed by the death of the first partner. Survivor benefits are typically 60 per cent of the base pension. In this case, given that Geoff is appreciably older than Mary, another pension problem will be loss of one OAS benefit, most of one CPP benefit and the opportunity to split her income with Geoff. The survivor could have less income yet wind up in a higher tax bracket.
Changing survivor benefits on pensions is usually not possible. They can reduce the survivor’s potential future income drop by investing savings to build a reserve for income loss when the first partner passes away. “That will improve the survivor’s odds of keeping the house and way of life,” Egan concludes.
IT’S IMPORTANT TO DISSECT THE COUPLE’S INVESTMENT INCOMES AND JOB PENSIONS.